Opinions & Interviews

2022-11-16 Roberto Ruozi

Financing the Ecological Transition

The transition towards a cleaner and more circular economy regards almost the entire global system of production and distribution. To achieve this transition, colossal investments will be needed, which evidently must be financed. The fundamental sources of that financing will be above all the classic sources, that is, the equity capital of public and private investors and the debt contracted by them with banks and the operators on the financial and securities markets.

The ecological transition has been a subject of debate for many decades now, with much said and written. In reality, in recent years it has reached crucial importance for the economic and social development of our planet. It is in fact a very complex subject, that is difficult to define, especially in practical terms, and changes continuously while regarding various areas, including the decarbonization of the economy, the circular economy, the reduction of the use of plastic, urban regeneration, sustainable tourism, and adaptation and mitigation of risks due to climate change. The solution to these problems, that is not at all easy and will in any event require considerable time, should ensure the transition towards a cleaner and more circular economy, based also on projects aimed at integrating production cycles with low-emissions technology to produce goods and services and ensure sustainable and smart mobility.

In essence, almost the entire global system of production and distribution is potentially subject to the transition, which to be achieved will require colossal investments, that evidently need to be financed somehow. The fundamental sources of that financing will be above all the classic sources, that is, the equity capital of public and private investors and the debt contracted by them with banks and the operators on the financial and securities markets.

The attitude of potential lenders concerning the investments necessary for the transition will have a decisive effect for the success or failure of the transition itself. In this regard, there are various problems, that regard above all the fact that it will not be possible to ask the world of finance – as many do now – to act as the driving force for investors and businesses in particular. This role would be entirely disproportionate with respect to the history and capacity of that world, which will only be able to operate in the context of industrial and social policies able to address the transition process promptly, and with adequate proportionality, to manage the costs, including social costs, and impacts on businesses and families. Those policies must somehow be harmonized with those of the banking system and other financial intermediaries.

This problem as well, though, has aspects that are complex, not entirely clear, and difficult to solve, especially because many fundamental qualitative and quantitative characteristics of the interventions to be carried out to solve it are not yet known, and they require knowledge of many detailed aspects and the general context in which the same problem is included. What sense is there in discussing detailed subjects without framing them in the broader context of the elements which may determine, merely by way example, banks’ success in financing sustainable transition processes from both the standpoint of methods and of quality of the insertion of new activities into the set of other banking activities, and the influence of the loans in question on the broader problem of the transition at the global level?

Indeed, among other things, we cannot but ask and seek to understand what relationships there must be between loans for the transition and traditional loans, what risk assessment techniques can be used to ensure success, what characteristics, cultures, and skills should the relevant personnel have, what types of controls will be necessary to ensure that the new machine functions in the best way possible and with governable risks, and so on.

I focus attention on the question of banks because they are what I know best, and also because as sources of financing banks will continue to be decisive for a long time in order to achieve the transition, especially in countries like ours, where the presence of banks in the overall system of financial intermediation is predominant.

In truth, until now such loans have been rather limited and have consisted mostly of the issuance and subscription of “green bonds,” more than granting short or medium-term loans for the specific purpose of the ecological transition.

As for green bonds, I recall that they have met with rapid and significant success, and that their issuance by large industrial or banking groups, or also by states, has been welcomed by the markets, especially because they have succeeded in presenting the various types of investments to be financed with relative clarity.

This is the right occasion to recall that the defining problems, still the subject of increasingly careful study by various specialized international organizations, are decisive to ensure the success, transparency, and control of the financial activities at the service of the transition.

There are macro-themes regarding the contents of the transition and its financial needs, the way those needs can be satisfied, and lastly the possibility and methods by which public powers, who are the primary parties responsible for defining and managing the transition, can incentivize potential financiers, including banks. These issues were discussed on the occasion of a recent meeting of the Italian Association of Scholars of Economics and Management of Financial Institutions and Markets (ADEIMF) in which some studies were presented on very specific aspects of the problem, that I think, however, took for granted everything that is upstream of them. Some of the studies highlighted the positive correlation between the price of loans to finance carbon emissions and emissions themselves in countries in which attention to climate policy is greater and thus those prices are lower, and it has also been demonstrated that the best performance of the businesses most sensitive to environmental problems can reduce risks for banks and insurance companies, thus mitigating phenomena of instability, just as green innovation reduces the risk of bank insolvency and the prospects for a fall in share prices of the banks more involved in the financing of the transition, that seem to have better prospects than other banks.

It is evident that the results of all these studies must be evaluated with care, especially taking into account the quality of the data they have used and the not-yet-precise definition of different variables representing various aspects of the transition. Despite this, it is interesting to notice that almost all of them go in the same direction, and this could augur well to evaluate the effectiveness of the choices made by the operators, and could also be a tool to arouse interest among those financial operators who have not yet decided to intervene directly and massively in regard to problem.