Environment and sustainability
Basel III made the financial system sturdier after the 2008 crisis. But rules built to prevent a repeat of the last financial crisis now risk slowing the climate transition. Emerging markets need hundreds of billions annually for the world to meet climate targets and stay on a net-zero path. With rule clarifications, targeted adjustments and smart reforms, a unique opportunity presents itself to align financial stability with climate needs and unlock vital private capital.
In 2008 the world discovered what happens when banks underestimate risk. Years of easy credit and fragile balance sheets culminated in a financial crisis that nearly toppled the global economy.
Never again, regulators vowed.
Out of the wreckage came Basel III, a new global rulebook for banks that sets how much capital they must hold to cover risks. Its guiding principle was to adopt a prudently conservative approach to risk, ensuring banks are better prepared for potential losses on the loans they issue.
That caution did its job.
Fifteen years on, banks are far sturdier than they were. When COVID-19 struck, they absorbed losses without a repeat of 2008-style government bailouts.
By the measure of financial stability, Basel III has been a success.
The rules designed to keep finance safe are now, inadvertently, choking off the very capital needed to confront what is arguably today’s greatest systemic risk, climate change. Emerging markets and developing economies (EMDEs), home to much of the world’s growth and most of its climate vulnerability, are at the sharp end.
EMDEs need an additional US$ 450 to US$ 550 billion of external investment each year by 2030 to remain on a net-zero path, according to the Independent High-Level Expert Group on Climate Finance. That may sound enormous, but in context it’s only about 1% of the combined annual revenues of the world’s 500 largest companies. At present, EMDEs receive a mere US $30 billion in private flows.
This finance gap is not just a development challenge, it is a global one.
Without investment in clean power, resilient infrastructure and adaptation in EMDEs, the world will miss its climate targets. This brings about a stark paradox, one in which governments demand more private finance for climate action, but a tight rulebook makes it harder for banks to provide it.
Public lenders such as multilateral development banks (MDBs) and development finance institutions (DFIs) exist to make riskier markets investable, by co-lending or offering guarantees – in effect, promises to pay if a borrower defaults. In short, MDB and DFI guarantees, along with blended finance structures, act as cushions that make projects significantly safer.
In principle, Basel III rewards this by lowering the capital charges that banks need to hold on loans backed by MDB and DFI coverage. In practice, the rulebook is so tight many guarantees don’t qualify.
Standard exclusions, such as for war or nuclear catastrophes often disqualify products, even though they substantially reduce real-world credit risks. Partial guarantees and blended finance structures face similar challenges to be recognised under Basel III rules.
A more effective rulebook, ICC’s network of members advocates, would update credit risk guidance to reflect how MDB, DFI and private insurance products actually work and ensure the real risk reduction they provide is recognised. Setting parameters for reasonable arbitration periods and recognising standard industry exclusions would allow capital relief without undermining safeguards.
But the list of blind spots doesn’t end there. Basel’s list of recognised MDBs has not kept pace with reality.
While not completely static, only a handful of new MDBs have made it onto Basel since the 1990s. Newer, highly rated institutions such as the New Development Bank by BRICS nations or CAF – the Development Bank of Latin America – are not included. Nor are DFIs such as Germany’s KfW or AFD, France’s Agence Française de Développement. This is a major missed opportunity to involve MDBs and DFIs with strong climate strategies and that could channel far more capital into climate-aligned infrastructure in emerging and developing economies.
Expanding the list of recognized development banks – coupled with guidance to clarify how their products should be treated – would be a quick win to free up bank capital to fund climate-related projects in EMDEs.
If guarantees are overlooked, project finance is arguably misjudged. This is lending not to a company per se but to a single project, such as a wind farm, where repayment comes from the project’s own revenues. Because projects are vulnerable in their early stages, lenders build in safeguards, including long-term purchase contracts, cash reserves, political risk insurance.
Yet Basel treats such loans as particularly fragile.
Under Basel’s standardised approach – loans slotted into categories, each with a fixed risk weight – projects under construction carry a 130% risk weight.
By contrast, an unrated company with no track record, and possibly far fewer safeguards, could carry only a 100% risk weight. This makes it more costly to finance a carefully structured project than an unknown company with little more than a balance sheet.
Under the internal-ratings approach – where large banks use their own models to estimate risk – regulators assume that the longer a loan runs, the riskier it becomes, requiring banks to hold back more capital.
That logic fits corporate lending, where fortunes can fade. But it misrepresents projects, which are riskiest at the start and safer once revenues flow.
Basel’s caution, while justified in some areas, risks overshooting in others.
Evidence bears this out. In fact, data from the credit rating agency Moody’s and Global Emerging Markes (GEMs) Consortium show that, once construction is complete, project finance loans in EMDEs often outperform corporate lending: default rates are lower and recoveries are higher if things go wrong. The credit rating agency S&P has even suggested raising its assumed recovery rates for project-finance debt to reflect this record.
The mismatch is stark.
On paper, project finance looks costly and unattractive.
In practice, it is one of the safest ways to fund infrastructure and climate projects in developing economies.
Risk weights should reflect data, we believe. This includes introducing dynamic risk weights that understand that the risk of default typically goes down over time. Until then, Basel will continue to effectively penalise the very structure most used for climate infrastructure investment.
While Basel does not formally link capital charges to sovereign ratings, it does so indirectly by capping how highly any borrower in a country can be rated. The effect is to make every project appear only as strong as the sovereign itself.
Consider a solar project in an African country with a B-rating, backed by a long-term power purchase agreement, insured against political risks and co-financed by an MDB. Economically, the risk is sharply reduced. Regulators, however, force banks to treat it as no safer than the country’s sovereign rating. In effect, the project will still have a 100%+ risk rating, severely deterring lending.
Some regulators already allow nuance, distinguishing between sovereign and project-level risk. Scaling up that flexibility would unlock finance for secure projects without ignoring genuine sovereign vulnerabilities.
At last year’s COP29 in Baku, governments launched the ‘Baku to Belem Roadmap’, to scale up climate finance for developing countries, aiming to mobilise at least US$1.3 trillion per year by 2035. COP30 in Brazil is a chance to move from pledge to practice, by setting into motion Basel III technical adjustments and clarifications that could yield an immediate boost to climate finance, while initiating a structured dialogue on broader structural reforms.
The EU has shown that carefully crafted reforms can work. Its Infrastructure Supporting Factor – a rule that lets banks treat certain reliable infrastructure loans as less risky, so they don’t have to hold back as much capital – has boosted investment without endangering stability. A similar scaling factor for high-quality climate-related investments in EMDEs could be a pragmatic next step.
Basel III has delivered on its promise of stability. But if rules built to prevent the last crisis now block finance for the climate transition, prudence risks tipping into paralysis. Better to overstate risk than understate it, regulators concluded after 2008. But what if the greater danger today lies in failing to act? Updating Basel is not about weakening safeguards. It is about aligning financial stability with planetary safety.
The last crisis showed the cost of underestimating risk. The next could reveal the cost of misjudging where it lies.
2025 is a critical year for the Paris Agreement. Ten years on, we need to rethink how we frame the challenge. And seeing challenges differently is what business and we are all about.
ICC is committed to securing what businesses need at the upcoming climate negotiations, COP30, in Belém, Brazil. Learn more about our Opportunity of a Lifetime climate campaign and how to get involved.
Targeted clarifications and reforms to the Basel Framework could unlock significant volumes of private investment in high-impact, climate-aligned projects in emerging markets and developing economies, while ensuring the continued soundness of the global financial system.
