University of Groningen

Public Financial Institutions and Climate Change

Xie, Lina; Scholtens, Bert; Homroy, Swarnodeep

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The Routledge Handbook of Green Finance

DOI:
10.4324/9781003345497-7

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Xie, L., Scholtens, B., & Homroy, S. (2023). Public Financial Institutions and Climate Change. In O. Lehner,
T. Harrer, H. Silvola, & O. Weber (Eds.), The Routledge Handbook of Green Finance (pp. 75-86).
Routledge. https://doi.org/10.4324/9781003345497-7

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 5
PUBLIC FINANCIAL
INSTITUTIONS AND
CLIMATE CHANGE
Lina Xie, Bert Scholtens, and Swarnodeep Homroy

Introduction
Climate finance is at the heart of addressing climate change.To limit the temperature rise to 1.5
degrees Celsius, more than 4 billion USD of climate finance is required annually by 2030 (see
Climate Policy Initiative, 2021). Raising such amounts is challenging given the already high and
rapidly increasing levels of public debt in relation to the impact of the Covid-19 pandemic and
rising inflation worldwide. The UN Climate Change Conference 2021 (COP26) reinforced
the importance of taking climate into account in every financial decision for both public and
private financial actors. As significant asset owners, public financial institutions (PFIs) provide
similar amounts of international climate finance as private institutions. Their investment alloca-
tion (e.g., shifting from carbon-intensive to low-carbon infrastructure) can substantially affect
the climate system and emission trajectories (Steffen & Schmidt, 2019). However, those PFIs are
underappreciated in the academic debate about their engagement in climate actions. To under-
stand the role and potential of PFIs in addressing climate change, we provide the basics about
these institutions and why and how they might help address climate change.
A commonly used definition of PFIs is that they are financial institutions initiated/owned by
governments with official missions to serve the public interest as defined by national, regional,
or international policy objectives (Cochran et al., 2014; Xu et al., 2021). As such, development-
oriented PFIs, for example, multilateral development banks (MDBs) such as the World Bank
and the African Development Bank, are the most typical PFIs in the financial system. They
have explicit investment mandates to support industrial development, structural change, regional
development, and innovation (De Aghion, 1999; Fry, 1988; Mazzucato & Penna, 2016). Some
PFIs are set up to help achieve specific policies, such as export-import lending and insurance
(the EXIM banks), society-wide transition financing, and climate financing (the green banks).
Furthermore, they can act as a catalyst in bringing private financial institutions to certain pro-
jects (Fleta-Asín & Muñoz, 2021; OECD, 2016). In this chapter, we extend the scope of PFIs
to all banks and asset owners in the public sphere (with government ownership), which can be
public banks owned by local authorities, public funds, and public insurers. They are on the rise
and account for a significant fraction of the financial system with their substantial assets under
management (AUMs). More specifically, it shows that the 27 trillion USD AUMs of public

DOI: 10.4324/9781003345497-7 75
 Xie et al.

pension and sovereign wealth funds make them the third-largest group of asset owners globally
(Megginson et al., 2021).
Figure 5.1 illustrates various financial institutions in both the public and private sectors and
their involvement in providing climate finance and conventional finance. PFIs are in quad-
rants II and III. PFIs that focus on facilitating and mobilizing climate finance, such as climate
funds and green banks, occupy quadrant Ⅱ. They are established to provide capital via different
financing mechanisms (e.g., in partnership with private investors) for climate change adaptation,
mitigation, and capacity-building activities in different sectors and regions (Chaudhury, 2020;
Michaelowa et al., 2020a). Adaptation aims to improve the vulnerable country’s resilience to
climate change and reduce risks of economic damage from climate incidents. Mitigation is to
reduce emissions and shift to a low-carbon development path. Capacity-building activities help
enhance a country’s technical and institutional capacity and ability to respond to climate change.
PFIs typically focus on underserved markets, where perceived barriers and lack of private invest-
ment slow the adoption of clean energy and related technologies (OECD, 2016, 2017).
The development-oriented PFIs operate in highly diverse fields, such as promoting national
and local economic development, small and medium-sized enterprises growth, and addressing
societal challenges like climate change. The significant international climate finance provid-
ers, MDBs, are committed to increasing their activities’ share of climate finance (MDBs, 2019,
2021). More and more national development banks (NDBs) and state investment banks (SIBs)
are integrating climate change into their investment decisions and promoting low-carbon and
climate-resilient (LCR) development (Geddes et al., 2018). The investment portfolios of those
PFIs consist of both climate finance and conventional finance. Therefore, they are positioned in
the middle of quadrants Ⅱ and Ⅲ.
Furthermore, other public banks and state-owned investors (SOIs, e.g., public pension
funds, sovereign wealth funds, and public insurance companies) are more oriented toward
providing conventional finance. They take deposits or manage households’ retirement plans

Public sector Private sector

Climate
finance International Green Banks
Climate Funds Private climate investors
Private climate funds
National
Climate Funds

MDBs
RDBs
BDBs NDBs
SIBs
Other SOIs
Public (i.e. Private Private Private
Banks SWFs, banks insurers funds
PPFs)

Conventional
finance

key International PFIs National PFIs Private investors

Figure 5.1 Public financial institutions in the financial system. Note: MDBs: multilateral development
banks; RDBs: regional development banks; BDBs: bilateral development banks, NDBs: national
development banks; SIBs: state investment banks; SOIs: state-owned investors; SWFs: sovereign
wealth funds; PPFs: public pension funds. Source: authors’ construction.

76
 PFIs and Climate Change

and transform them into loans, equity investments, and other financial vehicles. Given
their government ownership, they operate with public interest mandates and stakeholder
engagement (DSGV, 2018; Marois, 2021). Regarding climate change, some front runners
have started to align their investment portfolios with climate goals and actively promote
environmental and climate-related policies in their investee companies (Driouich et al.,
2020). For instance, the Environment Agency Pension Fund (UK) targets getting to net zero
by 2045, and the California Public Employees’ Retirement System (US) actively engages its
portfolio companies to encourage them to consider climate-related factors in their opera-
tions. However, the majority of them are less proactively engaged in providing climate
finance. This suggests the substantial potential for the public financial sector to address
climate change.
Private investors are positioned in quadrants Ⅰ and Ⅳ of Figure 5.1. Here, climate funds
are initiated by the private sectors in quadrant Ⅰ and are purely focused on providing climate
finance. For example, Bloomberg New Energy Finance (2022) tracked 2.8 billion USD in capi-
tal raised by climate-focused venture capital and private equity funds between December 2021
and February 2022. In addition, private banks and asset owners are raising their awareness of
climate change, assessing and managing climate risks, and integrating climate into their financial
decisions (e.g., participating in climate-related initiatives such as Principles for Responsible
Investment, Principles for Responsible Banking, and Climate Action 100+).
In the societal and academic debate, many studies focus on private investors in terms of their
motivations for considering climate factors and related impact on financial performance (Bolton
& Kacperczyk, 2021; Hartzmark & Sussman, 2019; Mazzucato & Semieniuk, 2018; Reboredo
& Otero, 2021; Riedl & Smeets, 2017; Trinks et al., 2018). Though private investors pursue the
maximization of shareholder value, they also can collaborate with PFIs to fund low-carbon
technology and innovation and to help turn the billions of public climate finance into trillions
of total climate investments. It is because, here, private and social interests align.

The Role of PFIs in Addressing Climate Change

PFIs play a crucial role in meeting the urgent need for upscaling global climate finance, given
their public features and climate-related market failures. They facilitate climate finance in two
ways: by providing their own resources and by mobilizing climate finance from private investors
(see Figure 5.2) (Migliorelli & Dessertine, 2019; NRDC, 2016). Left to the market alone, there
will be underinvestment in LCR projects. Market failures, presented with the externalities of
climate change, information asymmetry, and structural barriers in green innovation financing,
decrease the attractiveness of climate projects (Polzin, 2017). Especially private investors and
corporations with short planning horizons and prioritizing financial profits are reluctant to bear
related risks and engage in LCR investments (Egli et al., 2018; Le et al., 2020; Schmidt, 2014).
Government ownership allows PFIs to primarily pursue their policy objectives while trying
to break even financially, which sets them apart from private investors. The explicit or implicit
government guarantee enables PFIs to raise a substantial volume of stable capital and transfer
it to LCR projects at a lower cost (see Figure 5.2, capital provision), especially for projects
which are not able to access capital from the private sector (Mazzucato & Penna, 2016; Steffen
& Schmidt, 2017). The basic funding means include concessional loans, intermediated loans,
equity investments, guarantees, etc.Yet, given the already high public debt and the scope of LCR
investments in need, it is difficult for PFIs to provide sufficient climate finance on their own.
Therefore, mobilizing capital from private investors becomes the other important role for PFIs
in addressing climate change (OECD, 2016).

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 Xie et al.

Financial sector

De-risking
Private
Public financial instuons
Capacity building investors

Loans

① Capital ② Capital
Equity investment
provision mobilization
Other instruments
(i.e. climate bonds)

Low-carbon and climate-resilient (LCR) projects

Figure 5.2 PFIs’ role in channeling climate finance to LCR projects. Source: authors’ construction

Mobilizing private climate finance can be achieved through two channels. First, the involve-
ment of PFIs in LCR projects performs a de-risking role, namely decreasing the downside risk
of LCR projects (OECD, 2021; Schmidt, 2014). The relatively high risks and financing costs of
LCR projects form significant barriers to accessing capital from private investors. PFIs’ involve-
ment brings explicit or implicit risk insurance or guarantees (that cover potential losses) that
make LCR projects financially attractive for private investors. PFIs signal to the market that
those projects are commercially viable and, in turn, leverage private climate finance to LCR
investments (Geddes et al., 2018). In addition, with specific financing structures and arrange-
ments, PFIs’ involvement either shares or transfers the risk of LCR projects at different stages
among investors with different risk-return portfolios and then leverages more private climate
finance (Cochran et al., 2014). OECD (2021) analyzed 328 projects funded by institutional
investors with public interventions and recorded 19 de-risking instruments (the three most used
instruments are co-investment as an equity fund, loan, and stake cornerstone at the fund level).
Meanwhile, the public actors need to be aware of the potential crowding-out effect of public
climate finance. PFIs are expected to provide additional finance for climate projects lacking
sufficient funds due to market failures. Their investments in already bankable LCR projects
compete with private investors and, as such would crowd out private climate finance (Geddes
et al., 2018). It seems many institutional investments and public interventions flow to mature
technologies (OECD, 2021). PFIs might focus on higher-risk low-carbon technologies and
climate-resilience projects to provide additional climate finance.
Secondly, PFIs play a role in providing and building capacity and expertise regarding cli-
mate investment. Though the awareness and understanding of climate change and related risks
increase among both public and private investors, expertise in LCR investments and assess-
ing and managing climate-related risks are far from mature (Krueger et al., 2020; Stroebel &
Wurgler, 2021). Building capacity and fostering expertise become crucial for PFIs to attract
additional capital.Technical assistance is one of the typical financing types of development banks
for climate-related projects, especially essential for adaptation projects. Such assistance aims to
improve the ability of project developers regarding project preparation and strategic planning

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 PFIs and Climate Change

and strengthen the technical capacity of the capital market so that LCR projects have better
access to financing (United Nations, 2020).
PFIs also invest in researching and developing innovative financial tools and standards for
climate investments which are public goods that benefit all investors. Relying on the PFIs’
platforms and initiatives, climate investment expertise and knowledge are disseminated to more
project developers and investors (Driouich et al., 2020). Given the government ownership and
stakeholders’ engagement, PFIs can also be a bridge between governments and market actors,
advocating climate-related policies and regulations and promoting climate-related responsibility.
For example, the water bank in the Netherlands (a national promotional bank) set up a water
innovation fund to innovate sustainable water-related projects in the pilot phase (NWB Bank,
2022). It also actively funds sustainable energy projects supported by the government, such as
projects that received government grants and projects raised from public-private partnerships.
Many LCR projects are funded with traditional forms of loans and equity investments.
PFIs also developed many other financial instruments that leverage private climate finance, for
instance, mezzanine finance, quasi-equity, and off-balance sheet instruments (Cochran et al.,
2014; NRDC, 2016). In the green bond market, public sector actors take the lead. They issued
230 billion USD of green bonds in 2021, which accounted for 40% of the overall amount of this
type of bond issue. Issuance by PFIs like development banks and government-backed entities
accounted for more than 22% (Climate Bonds Initiative, 2021).

Geographic Dimension of PFIs’ Climate Finance

What is the destination of PFIs’ climate finance? As of today, an accurate answer is unavailable
due to data limitations. On the one hand, there are no consensus and systematic studies iden-
tifying PFIs of all countries. An exhaustive database of PFIs worldwide is still missing. Xu et al.
(2021) build the first database of over 500 public development banks and development financial
institutions worldwide, but many public banks and SOIs are not included. On the other hand,
only a few PFIs start tracking and reporting climate finance in their portfolio, and these data are
unavailable for most PFIs. Moreover, without a harmonized and jointly agreed accounting and
reporting methodology, the data cannot be aggregated and compared across countries (Shishlov
& Censkowsky, 2022; Weikmans & Roberts, 2019).
In this chapter, we adopt public climate finance data from Climate Policy Initiatives (CPI)
and eight leading MDBs to illustrate the geographic flows of climate finance from the public
sector. CPI aggregates international climate finance from all public actors (e.g., PFIs, government
budget, and state-owned enterprises) on the regional level (Climate Policy Initiative, 2021). In
2019–2020, more than half of public climate finance (180 billion USD) went to Asia Pacific
Region. CPI estimates most public climate finances were concentrated in China because of its
strong government involvement in public spending and policies.Western Europe, which consists
of developed economies, has sourced 13.8% of global public climate finance (43 billion USD).
The other economically advanced regions, namely the United States, Canada, and Oceania,
have sourced only 1.3% and 0.3% of all public climate finance. In those regions, climate finance
primarily comes from the private sector. Moreover, regions with the most vulnerable countries,
such as sub-Saharan Africa, the Middle East, and North Africa, sourced limited public climate
finance for their LCR projects (5.5% and 2.9%). Countries in those regions find it difficult to
obtain climate finance from the private sector (see Figure 5.3, panel A).
Data from the MDBs enable us to go deeper into the climate finance flows across coun-
tries. Eight MDBs1 developed common principles for finance to mitigate and support adap-
tation to climate change and reported their climate finance commitments across countries

79
 Xie et al.

Figure 5.3 Geographic flows of PFIs’ climate finance. Panel A: Public climate finance across regions
(2019–2020 annual average); Panel B: MDBs’ climate finance commitments across
countries (2015–2020 annual average). Note: transregional public climate finance is not
illustrated in this figure. The bottom-right box of Panel A is other Oceania countries, 0.3%.
Source: Global Landscape of Climate Finance 2021, Joint Report on Multilateral Development
Banks’ Climate Finance 2021.
between 2015 and 2020 (MDBs, 2021). MDB climate finance only includes the proportions
of project funds that directly contribute to or promote adaptation and/or mitigation. The
annual climate finance commitments made by MDBs between 2015 and 2020 were 51.4
billion USD, allocated to 172 countries. The geographic distribution of MDBs’ climate
finance is highly skewed. For example, EIB provided one-third of the climate finance to 18

80
 PFIs and Climate Change

European developed countries (17 billion USD per year). Climate finance from EIB consti-
tutes a significant source of public climate finance for Western European countries. The rest
was allocated to 154 developing and emerging countries in transition. Among them, the 12
largest recipients and the other 142 countries received a similar proportion (around 33%)
of climate finance from MDBs.

PFIs’ Climate Finance Priorities: Mitigation Versus Adaptation

PFIs’ climate finance is the primary source for developing countries to mitigate and adapt to
climate change, while developed countries mainly source funding from the private sector, espe-
cially the United States, Canada, and countries in Oceania. The data also confirm the highly
skewed distribution of PFIs’ climate finance. Moreover, this skew exists not only among coun-
tries but also between mitigation and adaptation purposes. Mitigation finance accounted for
86% of all CPI-tracked public climate finance and 75.6% of the eight MDBs’ climate finance.
Though adaptation projects heavily rely on funding from the public sector, they receive limited
funds from PFIs (see Figure 5.4).
Adaptation to climate change that improves economic and social resilience is imperative
because of the growing hazardous impacts of climate incidents (e.g., extreme weather events,
floods and droughts, and rising sea levels). Even if we achieve net-zero emissions immediately,
climate change impacts will last for the next few decades. Adaptation is unavoidable and urgent
in the short term, especially for least developed and most vulnerable countries (Klein et al.,
2007). Mitigation is to reduce sources or enhance the sinks of greenhouse gases (GHGs), which

100%

75%

50%

25%

0%
Public climate finance Private climate finance MDBs’ climate finance

Mitigation finance Adaptation finance

Figure 5.4 Public climate finance by mitigation and adaptation. Source: the two left bars use data from
CPI, indicating CPI-tracked climate finance (2019–2020 average) by mitigation and adaptation
from public and private actors. The right bar uses data from MDB-reported climate finance
from their own resources (2021).

81
 Xie et al.

requires significant efforts from major GHG emitters. Mitigation limits the concentration of
GHGs in the atmosphere and generates global benefits in the long term. Without mitigation,
adaptation will be impossible for some natural systems associated with tremendous social and
economic costs. However, because of the long duration of mitigation measures to take effect on
the actual climate, this implies that many people have to face increasing climate risks and sig-
nificant economic damages for a prolonged time. This seeming paradox reflects the real nature
of the climate crisis: the urgent need to protect vulnerable societies and ecosystems and the
pressure to cut emissions simultaneously.
The Paris Agreement brings the importance of the balance between mitigation and adapta-
tion finance to the table. Article 9 of the Paris Agreement states that the

provision of scaled-up financial resources should aim to achieve a balance between

adaptation and mitigation, and the allocation of climate finance should consider coun-
try-driven strategies, and the priorities and needs of developing country Parties, espe-
cially those that are particularly vulnerable to the adverse effects of climate change and
have significant capacity constraints.
(United Nations, 2015)

Whether this Article is implemented in the climate finance allocation, many studies investigate
the allocation of international climate funds and MDBs’ climate finance.
Garschagen and Doshi (2022) track and analyze the allocation of the World Bank’s Green
Climate Fund (GCF) and find it allocates its funds largely to vulnerable countries as it aims to
prioritize. They observe that the most vulnerable countries with weak institutional governance
cannot access project funding. Halimanjaya (2016) connects the recipient country’s carbon sink
with the mitigation finance allocation and finds discrepancies in the mitigation finance alloca-
tion of different donor countries. Michaelowa et al. (2020a) find that mitigation trust funds
allocate their funding according to recipients’ certified emission reductions, while adaptation
trust funds do not prioritize the most vulnerable countries.
We examine the allocation of MDBs’ climate finance and connect it to the country’s CO2
emissions and vulnerability to climate risks (Homroy, Xie, and Scholtens, 2021). From project-
level data of ADB, EIB,2 and IDBG, MDBs’ mitigation finance and adaptation finance are posi-
tively correlated with countries’ CO2 emissions, while their adaptation finance is not positively
correlated with countries’ vulnerability to climate risks (see Table 5.1). Furthermore, we simu-
late and predict future emissions and vulnerability under different scenarios of climate finance
distribution between mitigation and adaptation. We find that a more evenly balanced allocation

Table 5.1 
Correlation coefficients matrix of MDBs’ mitigation finance and adaptation finance, and
countries’ CO2 emissions and vulnerability

ADB EIB IDBG

Mitigation Adaptation Mitigation Adaptation Mitigation Adaptation

CO2 emissions 0.559*** 0.530*** 0.172** 0.488*** 0.709*** 0.326***

Vulnerability –0.074 –0.044 –0.151** –0.053 –0.149* 0.056

Source: mitigation and adaptation finance data are drawn from project-level data of ADB, EIB, and IDBG.
CO2 emissions data are the country’s total emissions from World Development Indicators. Vulnerability
data are the country’s vulnerability index from Notre Dame Global Adaptation Index.

82
 PFIs and Climate Change

between adaptation and mitigation finance (from 30:70 to 60:40) could substantially reduce
vulnerability to climate change for around 1.9 billion people.
Adaptation is one of the core topics juxtaposed with mitigation, collaboration, and climate finance
at the UN Climate Change Conference 2021. Adaptation projects face more barriers than
mitigation projects to obtain funding from the private sector, therefore rely to a great extent
on the public financing source. However, adaptation finance only accounts for a small fraction
of the public climate finance portfolio. Studies show that adaptation finance hasn’t reached the
most vulnerable countries (Garschagen & Doshi, 2022; Michaelowa et al., 2020b). To align its
finances with the investment portfolio with Paris Agreement Articles, PFIs must balance mitiga-
tion and adaptation finances and take the country’s climate priority into account. The COP26
Presidency (2021) also requests developed-country parties to consider doubling adaptation
finance to balance mitigation and adaptation.

Conclusion
The transition to a low-carbon and climate-resilient development path is increasingly urgent.
The sheer scale and risky funding on mitigation, adaptation, and capacity-building require sig-
nificant participation from public financial institutions. The public characteristics of PFIs enable
them to be used as an atypical climate policy instrument by governments, providing authorities
with more policy tools other than conventional regulations, subsidies, emissions trading schemes,
and carbon taxes.With implicit or explicit government guarantees, PFIs support specific climate
policies with specific financing tasks and fund cheaper than private institutions. They play a
crucial role in facilitating sufficient funds for climate projects. Besides traditional development-
oriented PFIs, such as MDBs and NDBs, we should also shed light on public banks owned by
local authorities and state-owned investors, which have substantial AUMs and great potential to
scale up climate finance.
Closing the climate financing gap is challenging for both public and private investors. We
have seen an increasing awareness of climate change and the related risks of PFIs. More and
more instruments and expertise are developed and accumulated. The balance between mitiga-
tion and adaptation finance must be highlighted during this process. Adaptation is not only
to protect against negative climate impacts but also to avoid long-term damage to communi-
ties and ecosystems and to provide lasting support for climate policies. Similarly, mitigation is
important to achieve the objectives of the Paris Agreement. Future emissions will exacerbate
vulnerabilities of communities and ecosystems consequently. Therefore, a more balanced alloca-
tion between mitigation and adaptation and human health and well-being dimension needs to
be considered by PFIs in their investment decisions.

Abbreviations and Acronyms

ADB Asian Development Bank
AfDB African Development Bank
AIIB Asian Infrastructure Investment Bank
AUMs assets under management
BDBs bilateral development banks
COP Conference of the Parties
CPI Climate Policy Initiative
EBRD European Bank for Reconstruction and Development

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 Xie et al.

EIB European Investment Bank

EXIM banks export-import banks
GCF Green Climate Fund
GHG greenhouse gas
IDBG Inter-American Development Bank Group
IsDB Islamic Development Bank
LCR low-carbon and climate-resilient
MDBs multilateral development banks
NDBs national development banks
OECD Organization for Economic Co-operation and Development
PFIs public financial institutions
RDBs regional development banks
SIBs state investment banks
SOIs state-owned investors
SWFs sovereign wealth funds
PPFs public pension funds
UK United Kingdom
UN United Nations
US United States
WBG World Bank Group

Notes
1 They are Asian Development Bank (ADB), African Development Bank (AfDB), Asian Infrastructure
Investment Bank (AIIB), European Bank for Reconstruction and Development (EBRD), European
Investment Bank (EIB), Inter-American Development Bank Group (IDBG), Islamic Development
Bank (IsDB), and the World Bank Group (WBG).
2 We only include EIB’s climate finance to developing and emerging countries here.

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