The following story is about how one country responded to disappointing Doing Business scores to reform its rules and regulations for its own benefit. Would discontinuation of this instrument mean its non-availability to others?
The above image is for illustration and is of iStock.
How one country responded to disappointing Doing Business scores
On September 16, 2021, the World Bank discontinued the Doing Business (DB) report, one of its flagship diagnostic products. This action follows what the World Bank called “a series of reviews and audits of the report and its methodology.”
The DB report, published each year since 2004, was one of the World Bank’s most influential reports in recent years. Every autumn, people around the world would wait eagerly and, in some cases, with some trepidation, for its release. Over time, the reports increasingly attracted the attention of heads of governments who wanted to see their countries do well in the rankings.
When the DB report came out in 2015, the Indian government was disappointed. Soon after taking office in 2014, Prime Minister Modi announced his government’s intention to bring India’s ranking into the top 50 within a few years. Several reforms were carried out in the following months, which the Indian government hoped would put India on a trajectory of rapid annual improvements in the ranking. The 2015 report (officially called “Doing Business in 2016”, since the World Bank always gave the report a forward-looking title) indicated only a modest improvement in India’s rank, from 142 to 130.
The World Bank explained to the Indian government that while several reforms may have been enacted on paper, Indian businesses did not report feeling an impact on the ground. Some responded, “What reforms?”, while others heard about the reforms but had not seen improvement on the ground. The reforms could not be officially recognized until the private sector reported real improvements. The World Bank suggested that the government put in place feedback loops to provide real-time information from businesses on whether the reforms were being well implemented. The government, instead of whining further about the scores, started working on such feedback loops. For several regulatory reforms covered by the DB indicators, it started surveying businesses on whether they felt any reform impact on the ground.
From February 2016 to May 2017, the government carried out a series of business-to-government (B2G) feedback exercises and focus group discussions (FGDs) on how much the businesses were aware of the enacted reforms and their views on the quality of reform implementation. Nine B2G feedback exercises were carried out. Topics covered construction permits (three surveys each in Delhi and Mumbai), starting a business (two surveys), and trading across borders.
The exercises revealed several implementation gaps, some major and some minor. An example is construction permitting. A business survey carried out in Delhi in March 2016 revealed the following implementation issues: a) significant lack of agency coordination—architects still need to obtain approvals from up to 10 different agencies; b) some facilities for online payment were not properly implemented and certain fees were still paid manually; c) very low awareness of the online system among users; d) no way to track the status of an application; e) information lacking on documentary and other requirements. In other words, the reforms had not gone far enough to have impact on the ground.
This feedback exercise helped generate several recommendations to address the deficiencies. These were provided to the Municipal Corporation of Delhi (MCD), and most were acted upon. Follow-up feedback exercises in October 2016 and February 2017 validated these actions while generating additional recommendations for further improvement. A similar effort was made in Mumbai.
The impact of these efforts can be seen in the trends in India’s performance on the “Dealing with Construction Permits” indicator. In the Doing Business in 2016 report, India’s ranked 183 on this indicator. Thirty-three procedures were involved taking 191 days according to the indicators. Two years later, the number of days had come down to 144 with a modest improvement in the rank to 180. The more substantial improvements came the following year when the DB report published in October 2018 indicated a reduction in the number of procedures and days required to 18 and 95 respectively. Still a long way to go but enough to propel India’s ranking on this indicator to 52. While all this improvement cannot be attributed to the feedback exercises alone, it is possible to trace a substantial part of this improvement to actions taken as a result of these exercises.
The Indian government also recognized that the DB indicators did not cover many regulatory interfaces that created problems for businesses and that the indicator measures were based on conditions in just two cities, i.e., New Delhi and Mumbai. Thus, in parallel to its efforts on the DB front, the Indian government embarked on an ambitious regulatory reform program at the state-level covering all states and union territories in the country. A long list of regulatory reforms was identified covering several regulatory areas, and state governments were instructed to carry out the reforms. Called the Business Reforms Action Plan, the program started in 2015.
Progress was monitored through annual indicators that ranked states according to their performance on implementing the reforms. The first such indicators, published in 2015, did not take into account business feedback. However, seeing the usefulness of the feedback exercises carried out as part of the DB program, the government changed the state-level reform indicators in 2018 by making a substantial part of the indicator scores dependent on business feedback.
The powerful demonstration effect of such feedback exercises had touched individual state governments too. In 2018, four state governments, Chhattisgarh, Jharkhand, Orissa, and Rajasthan, expressed an interest in knowing why there was poor uptake of self-certification and third-party certification options provided in business inspection reforms carried out by these states. At their request, the World Bank carried out an independent feedback exercise that could help design corrective actions to improve uptake.
The Indian experience from 2016 onward is a good example of what the DB indicators can lead to if governments use them well. First, the government refocused its attention from reforms on paper to reforms on the ground. Second, it recognized the importance of consulting with the private sector, which knows best where the shoe pinched, and designed corrective actions based on the feedback. This iterative process helped improve reform implementation quality. Third, the government recognized that while the DB indicators were useful, they were not adequate to diagnose the myriad of regulatory issues that businesses all over India faced. Thus, the government embarked on a more comprehensive, state-level, reform program, and, inspired by the power of indicators, underpinned this program by a set of performance indicators. Finally, once the pioneering DB-related feedback exercises proved useful, they created a demonstration effect, first within the central government, which replicated such exercises for the state-level reform program, and then on individual state governments.
Hadi Khatib on AMEInfo of 18 September 2021 came up with this deep statement on the anxiety list for MENA entrepreneurs that is long, as is the one curing it
The anxiety list for MENA entrepreneurs is long, as is the one curing it
A research report on the mental health challenges and wellbeing of entrepreneurs due to COVID-19 in the MENA region revealed anxiety has several facets in the minds of these leaders. But all of these insecurities have cures.
55% of startup founders said that raising investment has caused the most stress.
More than 95% of entrepreneurs view co-founders as family members and/or friends.
Research finds that entrepreneurs are happier than people in jobs.
EMPWR, a UAE-based digital media agency dedicated to mental health and an exclusive mental health partner for WAMDA and Microsoft for startups, published a research report on the mental health challenges and wellbeing of entrepreneurs due to COVID-19 in the MENA region.
The research indicated that startup founders undergo higher levels of stress than the rest of the region, with twice the likelihood of developing depression issues.
55% of startup founders said that raising investment has caused the most stress; the pandemic was the second most-cited reason cited by 33.7% of respondents. 44.2% spend at least 2 hours a week trying to de-stress.
Other insights, uncovered by the report, include:
A good relationship between co-founders can help startups navigate the pandemic-hit market. More than 95% of entrepreneurs view co-founders as family members and/or friends
Many entrepreneurs live well below their means to fund their ventures, leading to stress that is detrimental to their health
With only 2% of healthcare budgets in the MENA region currently spent on addressing mental health, the impact of the COVID-19 pandemic on young entrepreneurs and achievers could lead to an economic burden of $1 trillion, by 2030, according to the report.
EMPWR’s MENA partners shared special offers on their mental health services for the region’s entrepreneur community.
From Saudi Arabia:
Labayh is offering the technology ecosystem a 20% discount on their online mental health services for 2 months. Promo code: empwr, with the offer valid until October 29.
O7 Therapy are offering 50% off their online mental health services, for 50 Entrepreneurs in the MENA region. Promo code: Entrepreneur50, valid until December 1, 2021.
From the UAE:
My Wellbeing Lab is offering 20 one-on-one coaching sessions to entrepreneurs that wish to be coached and helped; alongside unlimited access for any entrepreneur to their “Discovery Lab”, a platform that gives entrepreneurs and leaders insights into their mental wellbeing as well as their teams. Promo code: MWL21.
Takalam is offering 10% off for 3 months. Promo code: Impact.
Mindtales is offering the MENA ecosystem 50% off their services for one month. Their App can be downloaded here.
H.A.D Consultants is offering 20 one on one coaching sessions to entrepreneurs. Promo code: HAD_SME01.
Nafas, a meditation app focused on reducing stress, anxiety, and help with insomnia, is offering access to its platform. Register as a user via this link to redeem benefits.
Entrepreneurs’ mixed emotions
Entrepreneurs must grapple with uncertainty and being personally responsible for any decision they make. They likely have the longest working hours of any occupational group and need to rapidly develop expertise across all areas of management while managing day-to-day business.
Work on the economics of entrepreneurship traditionally assumed that entrepreneurs bear all the stresses and uncertainties in the hope that over the long term they can expect high financial rewards for their effort. It’s false.
2. Highly stressful, but…
High workload and work intensity, as well as financial problems facing their business, are at the top of the entrepreneurs’ stress list.
But some stressors have an upside. While they require more effort in the here and now, they may lead to positive consequences such as business growth in the long term. Some entrepreneurs appear to interpret their long working hours as a challenge and therefore turn them into a positive signal.
3. Autonomy is both good and bad
The autonomy that comes with being an entrepreneur can be a double-edged sword. Entrepreneurs can make decisions about when and what they work on – and with whom they work. But recent research into how entrepreneurs experience their autonomy suggests that, at times, they struggle profoundly with it. The sheer number of decisions to make and the uncertainty about what is the best way forward can be overwhelming.
4. An addictive mix
The evidence review confirms that, by any stretch of imagination, entrepreneurs’ work is highly demanding and challenging. This, along with the positive aspects of being their own boss coupled with an often competitive personality, can lead entrepreneurs to be so engaged with their work that it can become obsessive.
So the most critical skill of entrepreneurs is perhaps how they are able to manage themselves and allow time for recovery.
Stress management tips for entrepreneurs
Identify what the actual source of your stress is. Is it tight deadlines, procurement issues, raising capital, managing investors’ expectations, building a talented team, or delay in landing the first sale for your new startup business?
Even if numbering more than a few, break them down because unmanageable tasks look simpler when broken down into smaller segments. Then, list down how you plan to successfully tackle each issue. Meanwhile, exercising multiple times a week has been rated as one of the best tactics for managing stress.
Another technique for handling stress is to take a break. Rest as much as you can before going back to continue with the tasks. It’s also a good idea to reach out to friends, family, and social networks because they are likely to understand what you’re going through and offer words of wisdom and courage.
Stay away from energy-sapping junk food. Eating healthy keeps you fueled for the next challenge. Finally, get enough sleep, and power naps. Sleep helps your body and mind recover.
Hadi Khatib is a business editor with more than 15 years of experience delivering news and copy of relevance to a wide range of audiences. If newsworthy and actionable, you will find this editor interested in hearing about your sector developments and writing about them. He can be reached at: firstname.lastname@example.org
A Bankers without Boundaries made a proposed mechanism to address the challenge of scaling energy efficiency measures in the urban built environment. It is suggested in this article as a Green Neighbourhoods as a Service for all concerned a welcome step in the right direction.
The above image is for illustration and is of Climate-KIC.
Reducing net energy consumption in the built environment is one of the most significant and hardest problems for cities to solve to meet net zero carbon timelines. In our experience, typically, these emissions contribute 30-40% to a city’s total CO2 emissions. In this article we look at why it is so challenging and propose a mechanism to kickstart retrofit at scale.
A Challenging Problem
Reducing emissions in the built environment is an extremely complex problem with multiple components. Many of these complexities arise from an underlying assumption, in nearly all jurisdictions, that solving the problem is the responsibility of individual property owners. Multiple individual actors must make independent decisions leading to a fragmented response to the challenge.
Even ignoring this fragmentation, targeting individual property owners with economic incentives alone is failing anyway due to two interlinked problems
The value of returns (energy savings) is not connected to the capital spend. Returns occur over many decades and a building owner must be confident that they will enjoy those benefits for at least 30 years to have a hope of creating a positive economic case. Most building owners cannot commit to owning the property over that period; therefore, the net present value of energy savings is undervalued by the capital spender relative to its true worth.
Even assuming the building owner can commit to 30 years of ownership, the economics of delivering deep decarbonisation in a way that is attractive to citizens (Deep, Community Retrofit) has poor economic returns (negative IRR) even assuming a 30-year investment period.
Figure 1: Not all retrofit is created equal
If economic rationale alone is not enough, decision making and financing must balance competing goals – economics, decarbonisation, community benefits and social & health impact, which requires a broader viewpoint than an individual building owner.
As a result, current solutions, which are frequently designed to be adopted by property owners, are failing. This has led to the paralysis we see in the market with negligible levels of building level improvements which improve energy efficiency (“retrofit”) occurring, despite various subsidy schemes being offered and financing costs being at historically low levels for some time.
Most existing solutions start with a premise that since it is down to individual property owners to commission work on their own properties, it is also therefore assumed that the energy and maintenance savings benefit accrues to them too and that this should form the economic rationale to carry out the project.
Even after discounting other barriers to entry (complexity of deciding what work to commission, project managing multiple trades, applying for subsidies, the misalignment of landlord and tenant incentives in the rental sector) the economic returns are not high for ambitious retrofit and require the property owner to remain in the property for decades to realise them. Therefore, the net present value of these savings is not being leveraged to solve the problem in the most effective way.
The sheer scale of retrofit that is required to improve inefficient buildings is also often touted as a problem. The costs of an ambitious retrofit programme are huge and go well beyond the public purse. To compound the problem the energy savings that can be achieved are not high enough for traditional financing on its own. To achieve this scale public finance will need to be blended with private capital in some way to provide the level of finance needed to achieve the scale required. In addition, retail investment and citizen engagement need to play their part in the equation to increase visibility and feasibility.
An interlinking issue for many countries is that of regional inequalities. Governments, such as the UK, have made levelling up regional differences a key policy initiative. Existing retrofit plans stand to exacerbate this issue. In the UK for example average house prices in London are £661k, but only £200k in the North East and North West. Average loan to value ratio is 82%. Retrofit costs are broadly uniform across the country, so a deep retrofit at £40k would equate to 6% of property value or one third of average equity in London, but 20% of property value or 110% of equity in the North. Clearly a policy led strategy that forces retrofit debt onto house owners would be deeply regressive for the North.
Any scalable solution must address the fragmentation of the problem which arises from individual decision making, allowing more systemic decision making to happen, economies of scale to materialise and progress to finally be made. This requires a fundamentally different approach.
There is also real opportunity in this space.
Figure 2: Opportunities
Green Neighbourhoods as a Service – A Proposed Solution
To address the mismatch between ownership of the capital spend and of the value of benefits, tackle the fragmentation issue, overcome barriers to entry, allow aggregation of projects and matching of different types of finance that will be needed, we propose a new more centralised model which we call Green Neighbourhoods as a Service (GNaaS).
GNaaS envisages the establishment of a central entity in a city or region which designs, commissions, manages and funds deep energy retrofit on a street-by-street scale with incremental community investments at no cost to the property owners, regardless of ownership and usage typology.
By centralising the design process, more systemic energy decisions are made, for example around local energy systems and integration with district heating.
By centralising procurement, greater economies of scale are realised, improving economics and providing a lead market to the supply chain creating an environment for investment.
By operating at a community scale, additional projects such as resilience building, co-working spaces and green infrastructure in the shared spaces can be implemented at lower marginal cost. This drives greater impact and citizen engagement, changing the process from a “retrofit programme” to a “neighbourhood greening and investment programme”.
By centralising funding, projects can be aggregated on a neighbourhood scale allowing access to completely different types of funding and crucially removing the requirement of indebtedness for individual property owners, which is a key barrier.
To fund the work, a mechanism is needed to attach the long-term energy and maintenance savings to the centralised funding source. The proposal is that this takes the form of a long term (30 year+) comfort and maintenance contract with the resident. The contract would be embedded into the property deeds so that it automatically novates to whoever lives in the property and does not follow the individual when they move away. Alternatively, the resident would be offered the option to contribute the funding for their property directly in which case they would receive the full benefits of reduced energy requirement going forward without any need to engage in the design, procurement and delivery process.
Figure 3: Operating Mechanism
This is not an ESCO model (1). The resident would retain their relationship with existing utility providers for any grid power that they require post retrofit. The significant reduction of energy use achieved through demand mitigation measures and maximising localised heat and electricity generation would create the financial space for the payment of the comfort and maintenance fee at no aggregate increase in cost to the resident.
Contracting all the energy and maintenance savings to the GNaaS organisation would maximise the potential for return-based finance in the funding model. Implementing governance structures that align the decision-making processes with the overall goals of the city could create a mechanism for social outcome goals to be included in contractual terms.
This mechanism could provide a theoretical lever to the public authority to leave part of the savings with the resident enabling the mechanism to become a powerful tool in tackling fuel poverty.
Figure 4: Funding Flow Through the OpCo / FinCo model
The Capital Stack That Will Be Needed
From the modelling work we have done with several cities, the internal rate of return (IRR) provided by the energy savings from this blended set of neighbourhood interventions is consistently negative, even assuming a 30-year payback period. But by considering a large enough layer of various non-repayable funding sources, or impact finance, we can move the IRR for the remaining funding requirement into positive territory. Furthermore, adding returns from other sources, e.g. health improvement, can further improve the pay-out profile.
The resulting model creates a potentially multi-billion, stable and low returning financial investment opportunity for sources of patient capital that also value a robust set of impact metrics such as decarbonisation, healthcare improvement, fuel poverty abatement, educational outcomes, air quality improvements or biodiversity gains. We would argue this could be a good fit for sources of capital such as pension funds and insurance companies, which are increasingly demanding products which offer impact related benefits in addition to a financial return, under pressure from underlying asset owners and regulators.
Further, it is a structure that can take in repayable, but zero or ultra-low coupon, finance from multilateral or development finance institutions seeking climate change impact and/or post-COVID recovery funding.
In addition, there is an opportunity to offer participation for local communities to invest through a community bond type structure allowing direct participation in the returns.
For the non-repayable layer of finance, various components will need to be combined.
Funnelling existing municipal budgets earmarked for improving energy efficiency of public owned properties into the mechanism
Repurposing existing subsidy schemes into the mechanism
Additional national/supranational grant funding schemes aimed at decarbonisation and/or post-covid recovery; the work is labour-intensive and community wealth building activities relating to asset maintenance and green infrastructure can be incorporated.
The potential to incorporate other outcome seeking pools of funding, for example allocation of healthcare budgets into what would become a preventative programme reducing future burden on the health care system, biodiversity improvement funding etc.
An option for building owners to fund the work themselves and have the occupant benefit from the energy savings. They still benefit from the centralised orchestration, better economics and broader impact.
Exploration of the potential to accredit such centralised and scaled retrofit programmes as sources of carbon credits for voluntary carbon offset schemes allowing corporates to achieve their own net zero targets by buying credits that directly improve the communities they operate in and their employees live in.
Figure 5: The proposed Capital Stack with illustrative figures
There are significant governance issues to solve in designing how this entity would operate and to align its actions with those of the public sector. We propose it would be a not-for-profit organisation using a standard return-based fund management fee structure to cover its own operating costs, with involvement from public sector officials in supervisory committees etc to ensure alignment.
We are not claiming that this proposal is yet a finalised solution; there are many complexities to work through (several which are being tackled in pilot projects planned in Milan and Zagreb). However, we are convinced that this concept has the potential to unlock the scaling of improved energy efficiency in the built environment in a meaningful way.
Integration with a mechanism to help scale beyond pilot phase, taking learnings from models like LABEEF in Latvia to enable an ecosystem of private sector contracting firms to take over the heavy lifting work of much of the OpCo envisaged above, thereby creating competition leaving the OpCo part of the retrofit company as a commissioning and refinancing engine for implementation firms.
Technical assistance funding is required to further develop this work, on the finance side, but also to develop the engagement process with citizens, scope out the legal challenges around contracting as well as integration with the supply chain
Pilots will need to be run in multiple cities to prove out the concept. We would envisage these covering 2-300 residential units at a total funding cost of €10-15m each. Pilots are in advanced stage of design in Milan and Zagreb) though engagement has begun in multiple cities across Europe including Copenhagen, Leuven, Vienna, Krakow and Edinburgh.
Funding providers, including private sector impact finance firms, development finance institutions and philanthropic outcome purchasers will need to engage who are willing to partner with cities to develop these structures so that they can grow to commercial scale.
1 ESCO – Energy Service Company – is a company that provides energy to customers and services to improve efficiency. An ESCO typically sits between the consumer and the utility providers.
Arabian Business posted DeBacker’s thoughts on how the Key combination for corporates targeting successful sustainability breakthroughs are the one and only remaining way out of today’s traumatic times. Here they are.
Key combination for corporates targeting successful sustainability breakthroughs
Through the convergence of technology, capital, and scale-up capabilities, industry incumbents can translate their sustainability visions to reality – ushering in a new chapter of green finance practicality
As corporates navigate persisting economic difficulties, unlocking growth and creating strategic advantages represents an entirely different sustainability challenge.
While transformational change has traditionally been hindered due to funding restrictions and expensive innovation projects, a new approach can now be pursued with the post-pandemic era approaching.
Through the convergence of technology, capital, and scale-up capabilities, industry incumbents can translate their sustainability visions to reality – ushering in a new chapter of green finance practicality.
Although this scenario may have seemed improbable not long ago, several trends have simultaneously transpired to lay the foundations for green financing breakthroughs.
Governments are engaging in heightened regulatory activity to build resilient economies and investors are prepared to pursue higher-risk green initiatives. Industrial companies are also introducing corporates to potential green technologies, while collaboration activities are broadening ecosystems via new players, partners, and opportunities.
Crucially, this applies to the Middle East, where the required framework and levers for green finance can benefit the wider corporate community and region exponentially. Green financing for sustainability projects increased by 38 percent to reach $6.4 billion in H1 2021 alone, while green finance is projected to create $2 trillion in economic growth and over one million new jobs by 2030.
These statistics certainly highlight the potential accompanying the green finance segment – and there are various innovative green asset and technology financing options available for interested parties to explore. Besides investment funds, project financing, and debt or equity investments, experts and commercial banks can facilitate technology deployments and green project acceleration through several green funding areas.
As corporates strive to achieve transformational change by acquiring capital, harnessing technology, and successful scaling their capabilities, they can do so backed by the following:
Sustainable bonds: Climate bonds are viable for mature investors seeking to introduce climate change solutions and projects, increasing available funding for green initiatives while providing positive sustainability benefits. Blue loans can also raise finance for projects within the blue economy, while ESG-linked finance is available and not linked to specific use cases.
Asset recycling platforms: As demonstrated courses of action from capital-intensive clean infrastructure, there are multiple asset recycling platform choices for corporates. Capital recycling designates funds toward greener projects, ‘farm down’ entails equity stakes being sold progressively, yield companies produce cash flow and returns through long-term contracts, and special purpose acquisition companies (SPACs) raise funding for capital-intensive startups – including $80bn in 2020.
Technology financing: Corporates exploring development expenditure (DEVEX) financing can utilise several sources depending on project technology readiness levels (TRLs). These include public funds for early investment and support, government-backed venture funds to complement private venture capital, and SPACs for sizeable technology funding.
Asset management: As Shariah investing emerged a decade ago as a desirable asset class, green financing is increasingly attractive capital with promising returns due the the profound change in economic make up, such as electric vehicles promising to overtake carbon fueled cars.
Admittedly, green financing options are bound by demands, aspirations, and conditions per each individual corporate, with eventualities dependent on specific factors. That being said, every corporate seeking sustainability finance can do so having taken note of similar instances in other sectors. In line with this, there are four actions one can take to help drive success:
Create a sustainable ecosystem
With an array of green technology ecosystems continuously welcoming partners specialising in different industries and technologies, corporates should prioritise developing and forming a sustainable ecosystem. This ecosystem should comprise technology, scale, and capital, which will be central to investment objectives coming to fruition.
While large companies already tend to be involved in multiple ecosystems, realising aspirations and achieving maximum value for many others hinges on proactive action in this direction.
Establish a comprehensive business model
No matter their readiness level, all corporates should pursue projects knowing that their assets or technologies becoming commodities starts and ends with a robust business model. Particularly during early development phases, models often have discrepancies in terms of clarity and direction. Therefore, corporates should define the value they are striving to build, identify the most prudent way to create cash flow, and decide where ownership and control will rest.
Deliver on priorities and objectives strategically
For businesses, executing every element of their business model requires a strategic approach. Whether this is done internally, via an external collaborator, or combining the two, successfully meeting targets and progressing requires a strategic roadmap that includes stakeholder alignment and ambition-timeframe balance.
Adapt the corporate governance model
From board to ethical investing, the corporate world is rethinking the way it creates value and governs itself. New oversight committees are formed in global complex companies to ensure consistency across multiple business lines and geographies – and this is something corporates should also pursue.
Backed by the most suitable innovative financing option, corporates have an opportunity to embrace the support available to them and make continuous strides towards sustainable growth breakthroughs.
The above steps will guide companies on their innovation journeys, with technology, capital, and scale-up capabilities simultaneously driving project success and green growth.
Philippe DeBacker, managing partner, global practice leader Financial Services, at Arthur D. Little.
Bibhu Mishra of Humboldt University, Berlin elaborates on Transitioning towards sustainable economy: Role of financial institutions such as Central Banks and financial systems in The Times of India.
Transitioning towards sustainable economy: Role of Central Banks and financial systems
“For peace to reign on Earth, humans must evolve into new beings who have learned to see the whole first”, said Kant.
Climate change is real; it affects and will affect everyone. Mother Nature sends its signals regularly, and most recently through the flash floods in western Germany. These signals are an urgent reminder that we need to take action now. The action must be collective, significant, timely, and futuristic because, in the long term, the risks outweigh the costs.
The Paris climate accord is one such step in the right direction. A holistic and stakeholder-driven approach would be required to achieve the target of maintaining temperature rise by 1.5 degrees Celsius. One of the most significant stakeholders in such efforts is the global financial system. The financial system’s role is pivotal because they provide finance and steer economic growth. Their actions have a significant impact on ESG, i.e., Environment, Society, and Governance.
There is a tremendous surge in investments which keeps ESG at the core of investment decisions. According to Bloomberg, ‘ESG assets may hit $53 trillion by 2025, a third of global AUM’. Despite a phenomenal rise in ESG assets in the past decade, the financial system still faces challenges like ‘short-termism’ and ‘greenwashing.’
Therefore, the role of Central Banks is vital. They look at the financial system of a country as a whole. Former Governor of the Bank of England, Mark Carney coined the concept ‘Tragedy of the Horizon’ to explain this. He argued, “the catastrophic impacts of climate change will be felt beyond the traditional horizons of most banks, investors and financial policymakers, imposing costs on future generations that the current one has no direct incentives to fix.” It is a tricky paradox where the current system has little or no benefits but to save the planet in its current state or better for the coming generations.
Realizing the importance of its role, eight central banks and supervisors created (In December 2017) a ‘Network of Central Banks and Supervisors for Greening the Financial System (NGFS).’The NGFS is aimed to make coordinated efforts to combat climate change. As of June 30, 2021, the NGFS has grown to a network of 95 members and 15 observers. The Network’s purpose, in their own words; “to help strengthen the global response required to meet the Paris agreement’s goals and enhance the role of the financial system to manage risks and mobilize capital for green and low-carbon investments in the broader context of environmentally sustainable development.”
The NGFS is a significant step towards bringing central banks of different countries together and ensuring that central banks take the leadership role in fighting against the climate crisis. In its first comprehensive report (Pub 2019), It came up with the following six suggestions and floated the idea of global collective leadership.
Integrating climate-related risks into financial stability monitoring and micro-supervision
Integrating sustainability factors into own-portfolio management
Bridging the data gaps
Building awareness and intellectual capacity and encouraging technical assistance and knowledge sharing
Achieving robust and internationally consistent climate and environment-related disclosure
Supporting the development of a taxonomy of economic activities
Additionally, the steps taken by the Central Banks of England (Bank of England) and France (Banque de France) are noteworthy and worth a mention.
Recently, the [Central] Bank of England launched a stress test for banks and insurers to understand the ability of the UK Financial system to cope with climate change. The test is aimed to examine the resilience of the UK’s 19 biggest banks and insurers. The stress test can also be looked at as an acknowledgement that Climate Change poses significant financial risks to the existing financial system. Therefore, early planning of a transition is necessary.
Moreover, ‘Banque de France,’ the central bank of France, took several initiatives to transition the financial industry into zero carbon. In June 2021, the French ACPR (Autorité de contrôle prudential et de résolution, English translation: French Prudential Supervision and Resolution Authority) published the first climate pilot exercise report an overall ‘moderate’ exposure to climate risks.
Let’s understand the risk through an example. Investing in fossil fuels may generate returns in the short term,’ but it will accelerate climate change and, hence, negatively impact the ESG. The negative impact on climate could cause erratic rains or severe drought, leading to an adverse effect on investments made in agriculture and allied sectors. One sector’s gain can be the loss of another sector, posing a significant risk before the overall financial system.
To ensure a smooth transition of the financial system towards sustainability and make it resilient from other systemic risks, early and coordinated action is needed. Central Banks and financial systems have a significant role to play in our journey towards sustainability.
Bibhu Mishra is a German Chancellor Fellow at Alexander von Humboldt Foundation and a researcher with Institute of Asian and African Studies, Humboldt University, Berlin.
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