Fundi Tshazibana: Scaling up blended finance - the role of financial
regulators
Keynote address (virtual) by Ms Fundi Tshazibana, Deputy Governor of the South
African Reserve Bank, at the Toronto Centre Workshop "Blended Finance: Barriers,
Opportunities and Implications for Financial Stability and Supervision", 25 June 2024.
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Good morning from London, where I am participating in the annual plenary meetings of
the Network for Greening the Financial System (NGFS). I thank the Toronto Centre for
inviting me to add the voice of the NGFS to the conversation that you are having on the
barriers and opportunities presented by blended finance, and by implication for financial
stability and supervision.
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The most recent analysis from the Climate Policy Initiative (2023) indicates an annual
average climate finance gap of between US$8.1 and US$9 trillion. Of this amount,
US$2 trillion is the estimated amount required for global investment in energy alone -
this amount is projected to increase, with estimates suggesting that global investment
needs to accelerate from current levels to well over US$4.5 trillion per year to transition
energy systems.
At the same time, we are faced with major obstacles to scaling up the financing of
climate action. In the aftermath of the COVID-19 crisis, fiscal space has diminished in
most countries. Deglobalisation and increased geopolitical fragmentation are likely to
slow economic activity, making future funding more difficult. Ageing populations require
additional fiscal support, even as the working-age populations in many economies fall.
These pose significant risks to economic and financial stability.
In this context, it is clear that unblocking constraints and scaling up the funding of
climate mitigation and adaption requires more integrated approaches and instruments
that take the present risk context into account.
Blended finance has emerged as an important tool to reduce project risks and increase
private sector financing, particularly in emerging and developing economies. Blended
instruments aim to reduce the cost of borrowing, increase funding and extend the
maturity of loans. The risk, however, does not disappear. It simply shifts from one
balance sheet to another that is better positioned to absorb possible losses. Effectively
supporting the development of blended instruments requires that we understand their
risk-sharing mechanisms.
As central banks, we are faced with three main questions:
1. How do we support the scaling up of blended finance?
2. How do we identify the risks embedded in different blended instruments?
3. How do we mitigate against them?
Today I hope to provide some preliminary responses to these questions. I hope that you
will spend time unpacking them in the remaining sessions of the conference.
First: How do we support the scaling up of blended finance?
The NGFS recently published several recommendations on how financial regulators
and central banks can support the scaling up of blended instruments. These
recommendations were based on several case studies which discussed recent
experiences with blended finance instruments.
Our assessment is that financial regulators and central banks can help with increasing
blended finance only as part of a broader country approach to addressing obstacles to
climate finance.
Some of the obstacles to blended finance include the absence of project pipelines or
macroeconomic instability due to fiscal crisis. These two obstacles require intervention
from fiscal authorities and other parts of government.
For some developing countries that are in debt destress, debt restructuring is required,
indicating that the success of blended finance instruments in these countries is directly
linked to the work of the Global Sovereign Debt Roundtable and mechanisms such as
the G20 Common Framework for Debt Treatments.
Examples of focus areas for central banks and regulators include addressing data gaps
so that financial institutions can price risk appropriately, embedding climate
considerations in governance and risk management practices, and understanding the
risk profile of different instruments so that these can be treated appropriately in the
microprudential framework.
Data gaps remain a major obstacle to increasing climate financing. Financial regulators
have an important role to play in addressing these gaps. Using appropriate taxonomy
and disclosure rules in their regulatory and supervisory approaches can improve
information flows and enhance the operations of financial markets.
Embedding climate considerations in the governance and risk management practices of
financial firms helps manage climate-related risks more effectively and improves the
allocation of capital across the economy. The NGFS's work on transition planning
provides important guidelines on how financial institutions can incorporate climate
considerations in all aspects of their operations and manage climate-related risks during
the transition.
Another important area to support the scaling up of blended instruments is around their
risk treatment in the regulatory and supervisory frameworks. Financial regulators face
increasing pressure to reduce the risk weights associated with blended financial
instruments. Lower weights can decrease capital costs and support the expansion of
blended finance.
This brings us to our second question. How do we identify the risks embedded in
different blended instruments?
In many cases, reducing the risk weights of blended instruments is justified. But is it
justified in all cases? We face several challenges in our regulatory treatment of blended
instrument. For example:
1. It is easy to understand the risk profile of some blended instruments such as
guaranteed loans. But other blended instruments have more complex structures.
It is difficult to create a universal framework for all blended instruments.
2. As I mentioned earlier, the risk does not disappear. It is shifted from one balance
sheet to another. This other balance sheet sometimes sits in the domestic
financial system and sometimes sits in another jurisdiction. For financial sector
supervisors, this creates a significant level of complexity around how we think
about the risk profile of blended finance. We need to understand the balance
sheets of the institutions that we supervise but also of those institutions that
provide risk insurance.
Many of our tools such as risk ratings and internal capacity adequacy are based on
historical data. Climate-related risks and those associated with new financial
instruments require forward-looking analysis, which is often characterised by high levels
of uncertainty. This often leads to a higher pricing of risk.
Global standard-setting bodies recognise this challenge and have prioritised
climaterelated risks in their work plans. Now to the last question. How do we mitigate against
risks related to blended finance instruments?
Many efforts to improve climate-related information flows in financial markets and
enhance reporting by financial institutions can help with scaling up blended finance by
helping central banks to better understand the risks associated with these instruments
and mitigate them more effectively.
This, however, is impossible without greater international cooperation as risks shift from
one jurisdiction to another. Blended instruments will increase financial linkages and
require a greater exchange of information across different jurisdictions.
Financial sector regulators need to develop new skills and research capabilities to
understand the various implications of the climate transition on the financial system.
More importantly, we need to understand how the combination of different structural
changes is likely to impact financial stability. For example, the rapid deployment of
artificial intelligence (AI), in addition to the climate transition, is likely to have profound
effects on the financial system and generate significant financial innovation.
Scenario analysis and transition planning can help financial regulators in understanding
future pathways and the associated risks. There have been advances and
improvements but data quality and consistency need to be enhanced, particularly in
emerging market and developing economies.
In conclusion, we need a massive increase in financing for the climate transition but
also to adjust to other structural challenges.
Central banks and financial regulators have an important role in ensuring that the
financial system is resilient to shocks and scales up fundings. However, our efforts to
increase blended finance or the use of other financing tools depends critically on how
our actions are coordinated within the broader policy environment. We not only need to
unblock unnecessary regulatory obstacles to new finance instruments but also need to
recognise that some of these instruments can pose risks to the financial system.
I thank you again for the invitation and encourage you to reflect on these issues in the
remaining sessions of the conference. All NGFS material is available on its website,
including the paper on blended finance and recently released papers on climate
disclosure for central banks, transition plans and recommendations on how central
banks' portfolio managers should develop sustainable and responsible investment
strategies.
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https://www.climatepolicyinitiative.org/publication/global-landscape-of-climate-finance2023/