Financing the net-zero transition: From planning to practice

Financial institutions will play a leading role in the transition to a net-zero economy. To maximize the opportunity, they must make fundamental changes across portfolios and organizations.

As facilitators of economic activity, financial institutions are vital contributors to global climate efforts. By providing the right finance to the right place at the right time, banks and investors can drive innovation, support scaling, and avoid an unruly transition to a greener global economy. In theory, these activities should generate a win–win scenario for providers and recipients of funding. However, there are also risks in marshaling the trillions of dollars of capital that will be required. To preempt potential headwinds, decision makers must establish processes, systems, and guardrails to protect themselves and the wider stakeholder community.

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Now is a critical time in the battle against global warming. According to a UN report from 2022, time is running out to limit temperature rises to 1.5ºC by 2050. 1 However, emissions continue to rise, reaching about 59 metric gigatons in 2019, about 12 percent higher than in 2010. 2 Against this concerning backdrop, the transition to net-zero global greenhouse-gas (GHG) emissions by 2050 would require $275 trillion of investment in physical assets. 3 In the near term, significant investment in clean power would be required to run electric vehicles and decarbonize buildings. Meanwhile, emerging markets and developing economies (EMDEs) need committed finance to ensure that the transition plays out across global value chains.

Contingent on a supportive environment, private financial institutions could facilitate as much as $3.5 trillion of annual financing between 2022 and 2050 (exhibit). Commercial banks could provide $2.0 trillion to $2.6 trillion a year, while asset managers, private equity, and venture capital funds could add $950.0 billion to $1.5 trillion. The task for all financial actors is to harness this opportunity while navigating significant strategic and operational demands in the context of evolving regulatory frameworks. Moreover, current incentives are not fully aligned with optimal pathways. For example, financing emission reductions (for example, through divestment of high-emitting assets) could produce higher rewards than financing emissions, which is also a key enabler of the transition. Finally, across the industry, data quality, analytical tools, and climate-related capabilities are variable and often lacking.

Private financial institutions could finance about 55 percent of net-zero investment needs.
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Capital deployment will require a collaborative effort among all stakeholders, alongside dedicated fiscal and regulatory tools and risk-sharing financial mechanisms such as blended finance. As these are put in place, financial institutions will need to build the internal capabilities that will help them engage effectively. At a basic level, this will mean defining net-zero targets and timelines to support the client transition, finance the green technologies of the future, and fund the early retirement of high-emitting assets.

Climate change finance is an evolving asset class, but it is already complex, with multiple products, capital structures, and regulatory requirements. Rather than shoehorn these structures into existing protocols, firms will need dedicated strategies across tools, policies, and processes. These will shape capital allocation, investment, and risk management, as well as support the definition of new products and services. To ensure these innovations have their intended effects, firms must engage effectively with clients over time. In many cases, this will mean rethinking workflows (for example, to ensure that relationship manager coverage models reflect client needs).

Finally, decision making will count. Dedicated governance frameworks will help business leaders oversee initiatives and align incentives with their strategic objectives. And creating cultures of decarbonization will encourage a concerted effort across organizations. Of course, systemic change requires significant innovation. New skills and capabilities will be required to help institutions manage risks and explore opportunities as they put their net-zero plans into practice.

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