Can a new catalytic finance bank unlock climate finance for the Global South?

There is now scientific consensus that climate change is an existential threat and the window for action is short. There is far less consensus on how we will pay for it. As US Treasury Secretary Janet Yellen put it, the [climate] funding need is in trillions of dollars a year and we have been working in billions. We need $3-5 trillion a year of climate finance from now until 2050. We are currently investing less than a fifth of that.

Even this limited investment is skewed: 80% is going to just two sectors: energy systems and transport (which account for less than half of greenhouse gas emissions) and 80% goes to the ‘rich countries’ of the Global North. The opportunity, however, is high in the Global South, where three-quarters of the infrastructure that will exist by 2050 is yet to be built.

Unless we can drastically transform the climate finance landscape in the next few years, we will not keep our ‘date with Paris’ of limiting temperature rise to well below 2 degree Celsius. We will hurl towards the doomsday scenarios that scientists project.

Governments are stepping up funding, but we shouldn’t hold our breath: the long-standing goal of $100 billion in climate finance flowing to the Global South by 2020 has still not materialised. And even this would be a drop in the ocean. Given the geopolitical realities and competing domestic priorities, expecting governments to shell out much more is unlikely. A lot of hope rests on private sector investment. And, despite its bold pronouncements, private capital is also constrained when investing in the Global South, where the perceived ‘risk premium’ is high due to currency, regulatory and political risks.

It is, therefore, time for a new paradigm of ‘public-private partnership’ for climate finance, where we need to get public funds as ‘catalytic capital’ to mobilise large amounts of private climate capital. Let's take an example. Financing a solar power project in many parts of Africa is today hard because of the perceived risk premium of investing in the region. The higher cost of capital for projects in Africa (~14-20%, vs. ~2-6% in Europe) makes them unviable. If public or concessional capital could come in and provide a ‘guarantee’ to cover for losses in case of certain events – e.g. payment defaults by consumers; regulatory risk, such as Power Purchase Agreements (PPAs) being rolled back or net metering tariffs being withdrawn – this could dramatically reduce the risk premium for private investors who would then be incentivised to commit.

This approach, being called catalytic or blended capital, is already catching on with $ 1.5 billion mobilized last year, but this is nowhere near enough.

The natural channel for advancing catalytic or blended capital approaches at scale are the multilateral development banks (MDBs), such as the World Bank and the regional development banks. In the era of climate change, the MDBs need to re-invent themselves and go from being ‘lending banks’ to ‘leverage banks,’ prioritising catalytic or blended capital projects so that their (limited) capital can unlock 8-10x more capital from the private sector. This requires a massive change in their ways of doing business and in their governance. This journey has begun, but again, it's happening at a glacial pace.

We need new ‘out of the box’ paradigms to turbocharge the catalytic or blended capital agenda.

One idea worth considering is setting up a ‘Global Climate Finance Agency’ (GCFA), that is a ‘catalytic bank’ (and not a ‘lending bank’) from its very inception. Such a GCFA could be seed funded by governments, much like the MDBs were, and by its charter focus exclusively on ‘leverage instruments,’ such as first-loss guarantees, mezzanine capital, project insurance and technical assistance, which are sorely lacking in the Global South for climate investment.

In addition to government contributions, the GCFA could be ‘capitalised’ by leveraging the Special Drawing Rights (SDRs) of the International Monetary Fund (IMF). An innovative proposal called the "Bridgetown Initiative” advanced by the Prime Minister of Barbados, has spelt out how these SDRs could be leveraged. SDRs are essentially the right of one IMF member to borrow a quantified amount of central bank reserves from another at low overnight interest rates (~2-2.5%). The GCFA (or a ‘Climate Mitigation Trust’, that the Bridgetown Initiative proposes) could use its paid-up capital and the SDR as security to raise say $500 billion at the low overnight interest rates from the private markets. This could then be deployed as blended/catalytic capital to qualifying projects (such as the solar example above) on the basis of how much and how fast they reduce emissions per dollar invested.

The establishment of a GCFA-like entity could be championed by the G20. After all, members of the G20 make up more than 80% of the world GDP and GHG emissions and the group is already engaged on the MDB reforms agenda. As the current president of the G20 and given its leadership role in setting up the International Solar Alliance (ISA), India is well-placed to lead and shape the conversation on a GCFA. This could well be a lasting legacy of its G20 Presidency and its climate leadership ambitions.