Africa, despite its low contribution to greenhouse gas (GHG) emissions, remains the most vulnerable continent to climate change impacts. It also hosts some of the lowest-income countries in the world, limiting the resources available for adapting to a heating planet. Seven out of the 10 most climate vulnerable nations in the world are located in Africa. Moreover, given the economic fallout of the COVID-19 pandemic, the African region faces its first recession in 25 years, according to a UN report, with output losses due to COVID-19 estimated to be USD $99 billion. This is compounded by climate impacts on economic output projected to cause annual losses of between 3-5% of GDP by 2030 under a business-as-usual scenario. In some cases, this will be as much as -15% of GDP.
Yet Africa’s potential to tackle climate change is immense and largely untapped. The continent boasts an almost unlimited potential of solar capacity, abundant hydro, wind, and geothermal energy sources. The International Renewable Energy Agency (IRENA) estimates that renewable energy capacity in Africa could reach 310 GW by 2030; which would put the continent at the forefront of renewable energy generation globally.
The financial sector and the banking sector in particular, should play a key role in mobilizing resources to investment in climate change migration in order to reduce GHG emissions as well as in climate change adaptation through building resilience. Africa’s commitment under the Paris Agreement presents a USD $3 trillion investment opportunity by 2030 – 75% of the investment is expected to come from the private sector to compliment the public sector financing. This calls for innovative approaches to attract and steer financial flows towards low carbon and climate resilient development solutions. Africa’s financial institutions are well placed as key stakeholders in the evolving global climate finance landscape, helping design solutions and mobilizing private capital for climate action. Climate finance is even more important in the wake of the COVID-19 pandemic. We are seeing a growing community of financial institutions taking action and demonstrating leadership on climate change and Africa must take a seat at the table. Increasingly, we are seeing that financial institutions can influence corporate behavior by offering loans and investments that factor in climate-related risks.
The impact of climate change poses a number of risks, however, there is a clear value proposition for the financial sector and how best to take advantage of these opportunities. The impact to the financial sector could range from increased premium costs for insurance companies to higher default risk with regard to banks non-performing loans. Despite these risks, climate change also poses opportunities that the financial sector can capitalize on. For instance, the market for impact investors is increasing but many banks still don’t understand how climate change could provide an opportunity and because of that they are not lending to impact investors who want to invest in that space. IRENA estimates that Africa requires an annual investment of USD $70 billion in renewable energy projects until 2030 for clean energy transformation to take place.
Over the past decade, several leading climate-change initiatives have been launched globally with the aim of involving financial sector actors to help leverage opportunities to drive climate action. More notably, the industry-led, UN-convened Net-Zero Banking Alliance brings together 53 banks from 27 countries representing almost a quarter of global banking assets (over USD $37 trillion), which are committed to aligning their lending and investment portfolios with net-zero emissions by 2050. However, African members are significantly underrepresented in almost all of these global climate action initiatives. Climate change is expected to accelerate and is no longer considered only as an environmental threat because it affects all economic sectors. Furthermore, climate-related risks are causing added risks for the financial sector. To mitigate the negative impacts, financial institutions and regulators must start undertaking various climate finance initiatives to mitigate those barriers. For example, South Africa’s Standard Bank has started working with clients to support climate adaptation and resilience and is actively seeking opportunities to finance infrastructure that helps with flood control, water efficiency, water storage and energy efficiency. One example of this is a climate-smart agricultural project with female farmers in Malawi.
The region must also leverage innovative approaches to attract and steer financial flows towards low carbon and climate resilient development solutions through sustainability-linked loans (SLL) and green bonds with greater participation of financial institutions. First issued in 2017, a SLL is an increasingly important part of the solution, enabling the banking sector to use their financial resources to drive sustainability outcomes. A SLL is a loan whereby apart from the standard financial criteria, there are also sustainability-related targets. Most of these loans contain incentives, and the idea is that when the company actually achieves the sustainability targets that were agreed upon, the interest rates that the company need to pay will go down, however, in some cases there is also the possibility of a penalty, meaning that if the company does not achieve any of the targets, the interest rate may actually go up. With a growing number of governments and companies adopting environmental, social and governance (ESG) principles, the global banking sector has recently seen a significant number of SLLs, which presents an opportunity to increase steadily across Africa.
Furthermore, the continent must accelerate developments in its nascent green bonds market. A green bond is a debt security issued by an organization for the purpose of financing or refinancing projects that contribute positively to the environment and/or climate. Green bonds have grown exponentially over the years, surpassing more than $1 trillion in issued bonds since the mechanism emerged in 2007. Despite growing demand globally, Africa lags behind other emerging markets. To date, there have only been 16 bond issuances, representing only 1.5% of total global bonds by number and less than 0.3% by value. Green bonds are a critical innovative financing mechanism that presents an opportunity to close Africa’s urgent infrastructure financing gap estimated between USD $68 billion – USD $108 billion a year – made more pronounced since the onset of COVID-19. South Africa currently leads, having secured a significant amount of the continent’s green bonds, with Morocco and Nigeria trailing behind.
Several aspects, however, can complicate these efforts. Better access to information is a critical component in the promotion of climate finance and other innovative financing mechanisms. There is no agreed upon set of regulations like with other aspects of traditional financial services. Without a clear regulatory framework, African financial institutions are left to determine for themselves an appropriate set of guidelines. Furthermore, this is made complicated by data gaps in the ability to monitor and assess climate-related risks to financial stability. By having more representation in these global climate action initiatives, African members can have a more active role in conversations to develop a harmonized set of climate-related risks, with guidelines for tracking and monitoring investments.
The financial sector can have an important role to play in helping Africa build resilience against climate change through promoting climate action and environmental risks in their credit and investment process. There is a clear opportunity for the continent to have a permanent seat at the climate change negotiating table to take advantage of the renewed focus on climate action and to promote a climate resilient and low-carbon economy while harnessing innovative approaches to address Africa’s urgent infrastructure financing gap . There’s not only a business argument in that there is now a much better understanding of the financial risks of climate change, but more importantly, increasing climate change effects on health, food and water security among other factors, are threatening socio-economic development in Africa.
Iftin Fatah is a Director, Financial Institutions at the U.S. International Development Finance Corporation. The views expressed herein are her own.