Yating Yuan: Hello, and welcome to the 10th episode of the Rock Environment and Energy Institute (REEI)’s podcast on the overseas think tank report on energy and climate change. I’m Yating Yuan (hereafter YT) from REEI.

Ye Lu: Hi, I’m Ye Lu (hereafter YL) from REEI, and the report we’re looking at today is the one published by the Climate Policy Initiative (CPI) think tank in August 2020, which is supported by UKPACT and the International Institute of Green Finance of the Central University of Finance and Economics. The report is titled: Green Banking in China – Emerging Trends with a Focus on ICBC. In this report, the experts provide an overview of green banking development in China, identifying key green banking policies and practices, results to date, and barriers to further expansion. They also present the practical development of green banking using commercial banks as management examples. Speaking of which, YT, can you introduce us to the CPI think tank, which is the organization that released this report?

YT: The Climate Policy Initiative (CPI) think tank was established in 2009 as an analytical and advisory organization with deep expertise in finance and policy to help governments, businesses, and financial institutions promote green economic growth while addressing climate change. With that said, YL, would you like to tell us about the development of green finance in China?

YL: Well, in 1995, the People’s Bank of China issued the Circular on Issues Related to the Implementation of Credit Policies and Strengthening Environmental Protection, which was the first policy on green finance in China, followed by the Green Credit Guidelines in 2012 and the launch of the Green Credit System in 2013. It was only after 2015 that the bank’s green finance policy expanded rapidly. YT, let’s explain the key features of the green credit system in detail.

YT: China’s credit statistics system for green loans is an essential feature of green credit policy. The China Banking and Insurance Regulatory Commission (CBIRC) has defined 13 green loan categories. Two of the most prominent green loan programs focus on energy efficiency and environmental protection, including energy-efficient buildings and green buildings, and those that manufacture energy-efficient products, green energy products, and green energy vehicles. This credit statistics system contains reports of green credit applications and green credit performance data, as well as non-performing loan (NPL) rates. It is a unique and innovative feature of China’s green credit policy.

YL: Yes, since the release of the Guidelines for Establishing a Green Financial System (2016), green credit policies have been adopted by various ministries and regulatory institutions, including providing direct financial incentives through monetary policy, long-term and medium-term lending instruments, as well as providing direct financial incentives through macro-prudential assessments. YT, can you tell us more about these policies specifically?

YT: Since 2018, banks’ green performance has become an important factor in the central bank’s public revenue management and macro-prudential assessment. The green credit policy approaches can be quantitative and qualitative, which is one of the seven areas of the macro-prudential assessment framework. The assessment framework consists of 80 percent of quantitative variables, such as the percentage of green loans, and 20 percent of qualitative indicators, such as whether banks issue green bonds. The capital reserve requirements are lower for banks with higher green loan balances and higher green bond issuance. This is, of course based on China’s NPL ratio statistics for green and non-green loans, but it also serves as some financial incentive in policy terms. In addition to the policy’s financial incentives, the report also mentions the banks’ green loan instruments.

YL: Concerning bank green loan instruments, the range of green finance instruments used by Chinese banks is broad and has grown rapidly in recent years. While there are no comprehensive statistics on the proportion of each instrument, it is worth noting that they are growing in diversity, spanning specialized instruments, collateralized approaches, asset-backed securities, and international green credit lines, such as 1) renewable energy loans, energy efficiency loans; 2) environmental credits, emission permits, and carbon asset financialization; and 3) increased cooperation with various international institutions to develop international green credit lines. This highlights how green banking can go beyond green loans and further support green bond markets and international green finance cooperation.

YT: Having said that, let’s look mainly at the financial performance of green credit. At the end of 2018, the NPL ratio for green loans was 0.42%, and the overall credit NPL ratio was 1.83%, which implies that green loans are less risky than other loans. Many green loans have been used for infrastructure projects, such as renewable energy generation projects, clean water and drinking water projects, and projects for improving the energy efficiency of transportation systems. These projects are already considered a relatively stable asset class. However, since detailed statistics are not available, it is not possible to control for the impact of other variables on NPL rates, such as debtors of state-owned enterprises, projects receiving public guarantees, or loans to heavily subsidized sectors. Nevertheless, the overall evidence is strong given that green loans represented 10% of the market over a six-year period. We can conclude that it is reasonable to empower financial system regulators to manage risk and maintain financial stability to include green factors in the governance of the financial system.

YL: In terms of trends, it is expected that the demand for investment in green industries will continue to expand, and the trend of green credit will continue to grow in line with the development of the financial system as a whole.

YT: The main barriers are in the areas of governance, policy, and the economic environment. At the governance level, the main barriers come from inadequate risk modeling and management. On the policy side, the current direct financial incentives are not enough to send a clear signal to banks to increase and drive investment in such companies to make the green transition at the same time; on the environmental side, the current penalties for high carbon projects are too limited to incentivize green credits.

YL: Yes, you just mentioned that the penalties for high carbon projects are limited. Specifically, companies can buy carbon in the carbon trading market to offset carbon emissions that exceed their allowances. However, the transaction prices are uneven across carbon trading markets. According to the 2019 carbon trading price, the average carbon price in Beijing is RMB 83.27/ton, and the carbon price in Chongqing is RMB 6.91/ton. It is much lower than the carbon price of RMB 203 per ton of CO2 in the EU carbon market, so the Chinese carbon trading market factors will not have a strong binding effect on high emission projects.  In addition, in the current economic environment, green projects tend to have high investment costs, long periods, and low interest rates. Although analysis shows that investment in labor-intensive, heavily polluting manufacturing and processing industries, which are traditional economic sectors, is becoming increasingly risky and the overall returns are decreasing, banks are still inclined to make larger profits in the short term.

YT: Let’s move on to a case study of the Industrial and Commercial Bank of China (ICBC) to better explain how green financing activities have evolved and how ICBC’s growing engagement with green capital markets has impacted its portfolio. Let’s start with ICBC’s contribution to green finance.

YL: ICBC is the largest contributor to green finance in China. In 2007, ICBC became the first commercial bank in China to implement green credit policies, which opened the door to the expansion of green loans. In 2014, ICBC also became the first Chinese bank to join the United Nations Environment Programme (UNEP FI) and signed the Statement on Environment and Sustainable Development, which helps Chinese financial institutions to participate in international rule-making in sustainable finance. In 2019, ICBC’s green loan balance was 1,350.8 billion yuan, accounting for 8% of total loans, and ICBC is playing an important role in accelerating the adoption of green practices across the banking sector by increasingly adopting green policies and lending practices.  It is setting an example for more Chinese financial institutions.

YT: In addition to this, ICBC has been working on expanding its green portfolio. ICBC has issued $370 million in green loans and in 2019 issued its first RMB-denominated “Green Belt and Road Bond” bond, totaling $2.2 billion.  This bond will be used to support green financing activities in regions along the Belt and Road. Most of the proceeds from the green bonds are used for Belt and Road projects, such as clean transportation, onshore renewable energy generation, and offshore wind power. However, the standards for green bonds in different domestic markets are not uniform, and it is difficult to align with international green financing standards, and some financial products are still far from the complete system of green financial standards. As a result, China’s green bond market cannot be further opened up, which hinders green bond interoperability and cross-border capital flows. The uneven distribution of the domestic green financial market and the lack of professional technical support are also significant obstacles to the development of green finance. Is there any data to reflect the status of green finance?

YL: In terms of factual data, fossil fuel financing activities still account for 14% of ICBC’s total financing, which ranks 18th in the world in terms of size. To date, there is no direct evidence that green finance practices have significantly reduced ICBC’s fossil fuel financing. However, the impact of green finance on ICBC’s overall balance sheet is negligible when fossil fuel financing activities are not considered in context.

YT: In conclusion, Chinese banks have enormous potential to contribute to decarbonization, not only for the Chinese economy but also for the global economy. Chinese policymakers are at the forefront of green banking policy innovation. Chinese banks are using a wide range of green credit instruments with increasing diversity, including specialized instruments, collateralized approaches, asset-backed securities, and international green credit lines. The ICBC case study shows that China Development Bank, Pingan Bank, and Huaxia Bank have all started to develop green finance. This is both in response to regulatory pressure and to seek new financial opportunities. So, what other roles does green finance play?

YL: Green finance also plays a role in the country’s efforts to build a resource-saving and environment-friendly society and continue to promote the goal of ecological culture. Green finance is a new economic trend that can combine both financial development and environmental protection and is an important tool to promote sustainable human development. Given the severe pressures on the Chinese economy, innovation and the ambition to continue to maintain a leadership position in green banking are particularly important. Even with a significant contraction in international trade and the impact of the 2019 new crown epidemic, prioritizing green banking remains an important step in addressing the changing global climate risks and driving a green transformation of the industry. The shortcomings of this report are the lack of reference to green banking in action and the omission of what practical positive impacts the banking sector has gained from the green finance trend, resulting in what low-carbon emission reduction financial decisions have been made, as well as what low-carbon emission reduction targets have been helped to achieve.

Text: Yating Yuan (Rock Environment and Energy Institute)