Establishing an Integrated Green Finance System in Nepal

Green finance is a structured financial practice that ensures a better environmental outcome. An integrated green finance strategy aims to promote a green economic transformation towards low-carbon, sustainable, and inclusive pathways as its primary objective. The concept of a green economy can be formalized as an economic system characterized by low carbon emissions, resource efficiency, and social inclusiveness. In a green economy, the focus is on infrastructure and resources that promote decreased carbon emissions, improved energy and resource efficiency, and the prevention of the loss of biodiversity and ecosystem services.

 

The Emergence of Green Finance

The emergence of green finance can be traced back to the 1990s, when the United Nations Environmental Program Finance (UNEPF) Initiative was launched and the Clean Development Mechanism was established, leading to the creation of carbon markets. During this time, the Equator Principles and the Principles for Responsible Investment were also adopted, marking the first investor network that focused on responsible and green investments. As the concept of green finance began to gain momentum, the European Investment Bank and the World Bank issued the first green bonds in 2007 and 2008, respectively. However, it was China that emerged as a first mover in this space, quickly becoming one of the world’s largest markets for green finance and renewable energy.

In the case of Nepal, the country has a robust history of investing in eco-friendly initiatives, particularly in the energy sector with a strong emphasis on hydropower. Although the government has implemented measures, such as requiring financial institutions to invest in the energy sector and extending credit to hydropower projects, these efforts have been insufficient. The introduction of guidelines on Environmental and Social Risk Management by the Nepal Rastra Bank (NRB) in 2018 has been a major driving force, however, more work is needed. In fact, the Alternative Energy Promotion Centre’s establishment of the Central Renewable Energy Fund in 2015 aimed to attract private sector investment in off-grid renewable energy projects which has been a promising step but further progress is necessary.

 

Why should Nepal green its financial system?

• To mitigate the risk of dominance in the brown sector

The banking sector holds the majority of Nepal’s financial assets, with a focus on the brown economy – sectors such as real estate, construction, agriculture, and forestry – ones that are vulnerable to environmental and climate-related risks. Ranking among the top ten nations globally, Nepal is severely impacted by climate change and the damages caused by it could amount to billions of dollars by 2050.

• To encourage private-sector investment

The Government of Nepal has a framework in place to encourage public funding of climate change, but greening the financial system would encourage more private sector investment in environmentally friendly industries like renewable energy and diversifying the bank portfolio. However, by 2030, the private sector, including Multilateral Development Banks (MDB) and local and regional financial institutions will be able to access an investment potential of USD 46.1 billion. The report by the International Finance Corporation (IFC) also highlighted that the potential can expand if Nepal focuses on Public Private Partnership (PPP) and integrates green financing policies.

• To hedge the economic cost of climate change

In April 2023, Kathmandu was designated as the world’s most polluted city, resulting in increased socio-economic burdens and citizen dissatisfaction with the government. Nepal is also ranked fourth most susceptible nation to climate change in the world, according to the 2022 Global Climate Vulnerability Index. The economic impact of climate change on Nepal is estimated to be between 1.5% and 2% of GDP, with the potential to rise to 2-3%.

 

How can green financing be integrated into Nepal’s existing financial system?

Many frameworks and policies have been established by the Nepali government to assist the green economy, sustainable development, and climate action. These include the Nationally Determined Contribution (NDC), the National Climate Policy 2019, and the National Planning Commission’s 2017 blueprint for Nepal’s Sustainable Development Goals: Status and Blueprint 2016- 2030.

Although a national roadmap outlining Nepal’s green finance strategy and a shared definition of “green” are crucial, there are ways for Nepal to make some small progresses to inch closer to the green financing goal by learning from other nations and standardizing approaches, which is further explained below:

Creating a green finance task force: Nepal should establish a Green Finance Task Force, drawing from China’s successful Green Finance Task Group for the development of green financing. The Task Force should consist of a team of experts from various fields such as ministries, financial regulators, banks, and academic institutions. Furthermore, international experts should be included in the team to provide a global perspective. In China, the Green Finance Task Group, established in 2014, identified the challenges and opportunities present in green finance and offered concrete recommendations for implementing green finance policies. Nepal needs to create a similar task force that caters specifically to its requirements, which can help in the design of a green financial system that is well-tailored for Nepal.

Encouraging Nepali Regulators in the Insurance and Security Market: Nepal’s membership in the Sustainable Banking Network brings a promising outlook for the country’s green finance regime. Collaboration between Nepali financial institutions, academic institutions, banks, and NGOs is crucial in establishing direct technical assistance channels with the rest of the world. Financial institutions in Nepal should create a customized “green finance” framework to meet their specific needs and ambitions. A bilateral channel between China and Nepal can aid in knowledge transfer and capacity building for Nepal to learn from China’s green finance experience. Overall, concerted efforts by stakeholders in Nepal, along with international collaborations, can enhance the country’s green finance regime and contribute to a sustainable future.

Adopting Green Financing: One of the most popular green financial products is green bonds. They are fixed-income instruments designed to fund climate and environmental projects having positive returns while benefiting the environment. The primary difference between green bonds and traditional bonds is that green bonds are exclusively issued to finance projects that positively impact the environment. Nepal could benefit from this type of financing; it needs to build its bond market infrastructure, broaden the issuer base, and ensure appropriate regulatory oversight. Green loans and guarantees are also viable alternatives to green bonds, particularly for smaller renewable energy projects that may have difficulty accessing traditional financing.

Ultimately, the use of green financial products can help Nepal achieve its climate and environmental goals while stimulating sustainable economic growth.

 

Conclusion

Green finance has become an increasingly popular field of investment worldwide, and Nepal needs to capitalize on green investment opportunities to transition toward a sustainable economy. The country is vulnerable to climate change with most of its financial assets in the brown sector, leading to potential climate and environmental risks. However, to achieve environmentally friendly and sustainable economic growth, the country must establish an integrated green finance system. A green financial system would provide incentives for increased private sector investment in green sectors such as renewable energy and diversify the portfolio of banks. This will help Nepal transition towards a sustainable economy, reduce its vulnerability to climate change, and generate economic growth.