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Climate action
Enhancing investment flows to emerging and developing economies: Rethinking green macroprudential regulations
Despite rising global climate investment, capital is not reaching emerging and developing markets (EMDEs). Growing evidence shows current Basel III global banking rule interpretations unintentionally discourage EMDE lending by underrecognising credit enhancement and blended-finance tools. Drawing on a Queen Mary University analysis of 40 countries, this report assesses climate risk transmission and how proportionate risk treatment can unlock climate finance without undermining prudential integrity.
Growing evidence suggests that macroprudential financial regulations – rules originally designed to protect the financial stability of the financial system as a whole – are inadvertently exacerbating imbalances in climate finance by discouraging, and even penalising, investment to emerging and developing economies.
One of the most significant barriers identified through stakeholder consultations across 40 developed, emerging and developing markets, is the persistent mispricing of risk. This results in substantially higher costs for banks to finance climate projects in EMDEs, compared to developed countries.
High capital requirements – the amount of capital a bank is required to hold against the lending – driven by sovereign risk ratings and standardised Basel III approaches, often overstate underlying risks, making green lending disproportionately expensive in these markets. Addressing these capital cost asymmetries is essential to unlock private investment for climate-aligned development.
Developed by Queen Mary University of London, in collaboration with ICC, this report examines how macroprudential regulations can be recalibrated to support climate-aligned and inclusive investment flows in EMDEs.
Drawing on a comparative analysis of 40 countries across OECD economies, emerging markets, least developed countries (LDCs), and small island developing states (SIDS) , the report evaluates how climate risks are transmitted through financial systems, the extent to which climate-related financial policies have been adopted, and regulatory readiness to support proportionate risk treatment in climate finance.
Key findings:
- Climate-related financial risks are insufficiently integrated into global regulatory frameworks. Physical and transition risks remain underpriced in both risk-weighted capital requirements and supervisory practices.
- Basel III standards, when uniformly applied, impose disproportionately high capital requirements on climate-vulnerable countries due to their lower sovereign credit ratings. This disincentivises green lending and infrastructure investment.
- Advanced economies and key emerging markets are taking the lead in climate financial regulation (e.g., stress testing, disclosure mandates), while LDCs and SIDS lag due to limited capacity and lack of tailored support.
- Climate finance flows remain heavily skewed toward mitigation in middle-income countries, with adaptation finance for LDCs and SIDS severely underfunded despite their urgent needs.
Policy recommendations:
- Adjust Basel III risk weights to account for climate vulnerability and verified green investments, lowering regulatory barriers for climate finance in SIDS and LDCs.
- Promote proportionate risk reflection in prudential frameworks by recalibrating Basel III risk-weighting methodologies to better recognise the de-risking role of credit enhancement tools – such as guarantees, blended finance instruments and insurance mechanisms. These instruments can substantially lower actual default risk in climate projects, yet their mitigating effects remain insufficiently acknowledged in current capital adequacy calculations.
- Deploy climate-aligned macroprudential tools, including brown-penalising and green-supporting factors, climate stress tests and climate-adjusted liquidity rules, tailored to local contexts.
- Mandate climate-related disclosuresand integrate climate risk into supervisory review processes (Pillar 2),
- Support Just Transition outcomes by embedding social equity criteria in macroprudential tools and safeguarding access to finance for MSMEs and communities affected by decarbonisation.
- Strengthen institutional capacity in developing countries and align international climate funds with local financial systems to improve access, pipeline readiness and regulatory coherence.
Enhancing climate finance in EMDEs through prudential regulatory clarification and reform
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.
