The global financial architecture, established primarily to ensure the stability of the international banking system, is increasingly coming under scrutiny for its unintended role in stifling climate-related investments in the world’s most vulnerable regions. A comprehensive new report, developed by Queen Mary University of London in collaboration with the International Chamber of Commerce (ICC), reveals that macroprudential regulations—rules originally designed to shield the financial system from systemic shocks—are inadvertently exacerbating imbalances in climate finance. These regulations are creating a punitive environment for investment in emerging markets and developing economies (EMDEs), effectively discouraging the very capital flows necessary to meet global net-zero targets.
The central thesis of the research, which involved extensive stakeholder consultations across 40 diverse markets, is that the current regulatory framework suffers from a persistent and systemic mispricing of risk. This mispricing results in substantially higher costs for banks attempting to finance climate projects in EMDEs compared to their counterparts in developed nations. As the world faces a closing window to address the climate crisis, the report warns that unless macroprudential rules are recalibrated to account for the unique requirements of climate-aligned development, the transition to a sustainable global economy will remain dangerously lopsided.
The Macroprudential Paradox: Stability vs. Sustainability
Macroprudential policy emerged as the cornerstone of global financial regulation in the wake of the 2008 financial crisis. Its primary objective is to mitigate systemic risk—the risk that the failure of one institution or a sharp drop in asset prices could trigger a wider collapse of the financial system. Central to this approach are the Basel III standards, which mandate that banks maintain specific capital buffers against their lending portfolios.
However, the Queen Mary and ICC report suggests that these "safety" mechanisms are now acting as a barrier to progress. The amount of capital a bank is required to hold against a loan—known as capital requirements—is heavily influenced by sovereign risk ratings and standardized risk-assessment models. In EMDEs, these ratings are often low due to historical volatility or political instability, regardless of the viability of a specific green project. Consequently, banks must set aside disproportionately large amounts of capital to back loans in these regions. This "capital cost asymmetry" makes green lending in emerging markets significantly more expensive, often rendering vital renewable energy or infrastructure projects economically unfeasible.
Chronology of the Regulatory Evolution and the Climate Gap
The tension between financial regulation and climate goals has been building for over a decade. To understand the current impasse, it is necessary to trace the timeline of how these two worlds—global banking regulation and international climate policy—have intersected.
The journey began in 2010 with the introduction of the Basel III Accords. Developed by the Basel Committee on Banking Supervision, these rules were a direct response to the global financial crisis, focusing on bank liquidity and capital adequacy. While they succeeded in making the banking sector more resilient, they were not designed with environmental objectives in mind.
In 2015, the landscape shifted with the adoption of the Paris Agreement. For the first time, nearly every nation committed to limiting global warming to well below 2 degrees Celsius. Article 2.1(c) of the agreement specifically called for "making finance flows consistent with a pathway towards low greenhouse gas emissions and climate-resilient development." Despite this mandate, the underlying banking regulations remained largely unchanged.
By 2017, the Financial Stability Board (FSB) launched the Task Force on Climate-related Financial Disclosures (TCFD). This marked the first major attempt to integrate climate risk into financial reporting. However, the focus remained on "risk to the bank" (how climate change might hurt financial institutions) rather than "risk to the planet" (how financial regulations might prevent climate action).
The years 2020 through 2023 saw a surge in "green taxonomies" and ESG (Environmental, Social, and Governance) investing. Yet, as the Queen Mary report highlights, these voluntary or disclosure-based measures have failed to offset the heavy weight of mandatory macroprudential requirements. The current report, released in 2024, serves as a critical intervention, providing the data necessary to argue for a fundamental shift in how risk is calculated for EMDEs.
Supporting Data: The High Cost of the "Green Squeeze"
The report’s findings are backed by a comparative analysis of 40 countries, ranging from OECD powerhouses to Least Developed Countries (LDCs) and Small Island Developing States (SIDS). The data paints a stark picture of financial inequality.
In developed markets, the cost of capital for renewable energy projects typically ranges between 3% and 5%. In contrast, the same projects in EMDEs often face costs exceeding 15%. A significant portion of this disparity is attributed to "sovereign ceilings"—a regulatory practice where a private project’s credit rating is capped by the rating of the country in which it operates. Even if a solar farm in an emerging market has guaranteed revenue and world-class technology, it is treated as a high-risk asset because of its geography.
Furthermore, the study found that the "Standardized Approach" to credit risk under Basel III—used by the vast majority of banks in developing regions—is far more punitive than the "Internal Ratings-Based" (IRB) approach used by major international banks in the West. This creates a dual-speed system where local banks in EMDEs are unable to compete or provide the necessary liquidity for local climate transitions because their regulatory burden is too high.
Stakeholder Reactions and Official Responses
The release of the report has prompted a range of reactions from the international community, highlighting the divide between financial regulators and development advocates.
The International Chamber of Commerce (ICC) has been vocal in its support of the findings. Secretary General John W.H. Denton AO has previously emphasized that the global community cannot achieve its climate goals if the regulatory system effectively "redlines" the developing world. In response to the report, ICC representatives have called for a more "proportionate" approach to risk, arguing that climate finance should not be viewed through the same lens as traditional commercial lending.
From the academic side, researchers at Queen Mary University of London argue that the current system is intellectually inconsistent. They point out that while regulators are concerned about "stranded assets" (such as coal mines losing value), they are failing to incentivize the "productive assets" that will replace them. Dr. Rodrigo Olivares-Caminal, a lead researcher on the project, noted that the report provides a roadmap for "recalibrating the scales" to ensure that macroprudential policy supports, rather than hinders, the flow of capital to where it is most needed.
However, some voices within the central banking community remain cautious. Representatives from several European central banks have expressed concerns that loosening capital requirements for "green" assets—often referred to as a "Green Supporting Factor"—could undermine the safety of the banking system if those assets turn out to be riskier than anticipated. This tension between "financial stability" and "climate urgency" remains the primary hurdle for policy reform.
Key Findings: The Transmission of Climate Risk
The report identifies three primary channels through which climate risks are transmitted through financial systems and how current regulations fail to address them:
- Physical Risk Transmission: LDCs and SIDS are disproportionately exposed to the physical effects of climate change, such as sea-level rise and extreme weather. Current regulations often respond to these risks by making insurance and credit more expensive or unavailable, creating a "vicious cycle" where the most vulnerable are unable to afford the protection they need.
- Transition Risk Mismanagement: As the world moves away from fossil fuels, the risk of economic disruption is high. However, the report finds that regulatory frameworks in many EMDEs are not yet equipped to manage this transition, leading to a "disorderly" shift that scares off private investors.
- Regulatory Readiness Gap: There is a significant disparity in the "regulatory readiness" of different nations. While OECD countries have advanced frameworks for climate-related financial policies, many EMDEs lack the technical capacity to implement complex risk-weighting adjustments, further isolating them from global capital markets.
Policy Recommendations for a Recalibrated Future
To bridge the climate finance gap, the Queen Mary and ICC report outlines several critical policy recommendations:
- Revision of Risk Weights: Regulators should consider lowering the risk weights for climate-aligned investments in EMDEs, particularly when those projects are backed by multilateral guarantees or have proven cash flows.
- Adoption of the "Green Supporting Factor": Similar to the "SME Supporting Factor" used in some jurisdictions to encourage lending to small businesses, a Green Supporting Factor would allow banks to hold less capital against environmentally sustainable loans.
- Enhanced Technical Assistance: International bodies should provide increased support to regulators in EMDEs to help them develop the sophisticated data systems required to move from standardized to internal ratings-based models.
- Blended Finance Integration: Governments and development banks should use public funds to "de-risk" projects, but macroprudential rules must be updated to recognize these de-risking mechanisms officially, allowing private banks to lower their capital allocations accordingly.
Broader Impact and Global Implications
The implications of the report’s findings extend far beyond the technicalities of banking law. At stake is the integrity of the Paris Agreement and the stability of the global economy. If EMDEs—which are expected to account for the bulk of future growth in energy demand—are unable to access affordable finance for clean energy, they will be forced to rely on cheaper, carbon-intensive alternatives. This would make it mathematically impossible to limit global warming to 1.5 degrees Celsius.
Furthermore, the "cost of capital" gap risks creating a new form of economic divergence. While developed nations use their low borrowing costs to build the industries of the future, developing nations may find themselves trapped in debt cycles, paying high interest rates for the very technology they need to survive.
The Queen Mary University and ICC report serves as a definitive call to action. It suggests that the definition of "financial stability" must be expanded. In the 21st century, a financial system that is "stable" in the short term but facilitates the long-term destruction of the biosphere is not truly stable. Recalibrating macroprudential regulations is not just a matter of banking reform; it is a prerequisite for global survival. As the international community prepares for upcoming climate summits, the focus must shift from "how much" finance is needed to "how" the rules of the game can be changed to let that finance flow.
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