Seminar in Applied Finance
The role of green finance in supporting the low-carbon transition
Author Bc. Matej Ingrst
Fürst Franz Joseff Strasse 17
00420 724 920 045
Matej260@seznam.cz
FS220268
University of Liechtenstein
First assessor: Sabrina Urban, MSc
Thesis project duration: 21.09.2023 to 05.12.2023
Date of submission: 05.12.2023
The role of green finance in supporting the low-carbon transition
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Table of contents
Introduction 3
1.1 Relevance 3
1.2 Research questions 4
1.3 Methodology 5
Green finance mechanisms 5
1.4 Definition of green finance mechanisms 5
1.5 Promotion of sustainable development 6
Green finance and transition to a low-carbon economy 7
1.6 Low-carbon economy 7
1.7 Effect of green finance on low-carbon economy transition 8
1.8 Investments in green finance and its effects 9
Conclusion 10
List of reference 12
List of figures 14
List of abbreviations 15
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Introduction
Industrial development in the 20th
century had some negative consequences, environmental negative
aspect is one of them. In the modern days, it is important to deal with sustainability across different
sectors. That is also the case for finance. Therefore, sustainable finance is becoming a big topic with
investors investing in sustainability (green finance) such as renewable energy, green bonds, green
loans et cetera. It is worth to explore the relation between sustainable finance investments and change
in carbon emissions, environmental concerns in general.
1.1 Relevance
To begin with, even in modern days, there is a large percentage of society, who does not believe the
climate change exists. This problem was examined by Afzali et al. (2023) in the article Climate change
denial and corporate environmental responsibility, where they found, that countries with higher
percentage of climate change denial have worse performance of corporate environmental
responsibility. Reasons to invest in sustainable finance might be various, other than profit, one might
want to make an impact, to feel better. This behavior was researched by Heeb et al. (2023), one of
their findings on a representative sample of the Swiss population was, that the opportunity to invest in
a climate-conscious fund does not erode in individuals` support for climate regulation. Bauckloh et al.
(2023) examined the missing risk factor in CAPM, which they consider to be the brown premium – the
premium for the fact the company is polluting, therefore more sensitive for potential green
government regulations. They also concluded that only those investors, who do not have
environmental taste are profiting from this as they are getting pollution premium. Kashif (2022) found,
that a higher rated ESG portfolio does not have different downside risk compared to lower rated ESG
portfolio, therefore suggesting, that investing on ESG criteria is a style based rather than risked based.
This might implicate positive approach of society towards measures of ESG. On the other hand,
Gilchrist et al. (2021) claim, that environmentally responsible practices not only enhance shareholder
value but also the value accrued to nonfinancial stakeholders. They also provide an updated overview
of research developments in relation to green bonds and syndicated loans.
Tran et al. (2020) researched factors affecting investments via green mechanisms with a focus on
Vietnamese market, one of the main drivers were awareness on accessing green capital.
One of the goals of this paper will be to investigate relationship between green finance and the
transition to a low-carbon economy. This problem was researched by Monasterolo et al. (2022), they
focused on green financial sector initiative in emerging markets and developing economies. The paper
investigates the transmission channels through which it affects the availability and cost of capital for
high- and low-carbon goods, investments, output, and greenhouse gas emissions. Li et al. (2022)
specifically investigated if green finance facilitated China`s low-carbon economic transition on 30
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Chinese provinces between 2001 and 2019. They used the Global Malmquist-Luenberger index as a
measure. Findings of Li et al. (2022) were that green finance can significantly contribute to the
transformation of low-carbon economy.
Yang et al. (2022) examined if renewable energy investments have effect on carbon dioxide emissions
reduction, they used data from 2010 to 2019 from 13 different countries. They found that increasing
renewable energy investment scale can indirectly reduce carbon dioxide emissions through the
technique effect and increase carbon dioxide emissions through the multiplier effect. Particularly, they
found that increasing investment in wind energy is significant in reducing carbon dioxide emissions.
The contrary effect was observed for increased investments in solar and bioenergy. This paper will
also focus on the question of how well different green finance mechanisms are promoting sustainable
development. Bhutta et al. (2021) analyzed factors associated with the impact of green bonds` on
issuers fundamental performance measures to meet ESG objectives. The review of Bhutta et al. (2021)
emphasized that financing is essential to support sustainable development with green bonds being one
of the instruments. They say that growth of green bonds popularity is secured by favorable regulatory
environment and improvement in disclosure quality. Other impact highlighted by the authors is the
characteristics of the issuer and the fact if they provide some advantages over other financial securities.
Tolliver et al. (2019) created an extensive overview of green bonds issued in 96 countries between
2008 and 2017, they claim, that the examined portfolio of green bonds is associated with over 108
million tons of carbon dioxide in greenhouse gas emissions reductions and over 1500 gigawatts in
renewable energy capacity. The study is examining green bonds in relation to the Paris Agreement
under the United Nations Framework Convention on Climate Change and the Sustainable
Development Foals (SDGs) of the United Nations Development Program.
Zhu et al. (2023) claim that green finance plays a significant role in the low-carbon economy as they
correct capital mismatch, promote green technology innovation.
1.2 Research questions
The paper focuses on answering following two research questions stated in this section. What is the
relationship, in terms of changes in carbon emissions and investment in renewable energy, between
green finance and the transition to a low-carbon economy?
How do different categories of green finance mechanisms, such as green bonds and green loans,
compare as to how effective they are at promoting sustainable development?
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1.3 Methodology
Research conducted on the selected topics is based on reading various up to date articles published in
relevant journals and their critical analysis. Therefore, this paper serves as an overview of already
performed research by other authors and summerizes their results and opinions into one paper. Many
papers from various authors were selected in order to fully understand and present results and
specially to answer the research questions stated above. The rating of scientific journals is also
considered in the choice of papers used for conducting further research.
Green finance mechanisms
Green finance is becoming trendy in recent years, not only for its relevance of climate change and
efforts for economical sustainability, but as stated by many researchers, also for the possibility of
diversification, managing risk and even by offering further premia in case of environmental disstress.
The goal of green finance mechanisms is to structure financial activities in order to create a better
environmental outcome. As stated by S. Fleming (2023) the value of green bonds traded is over
$2.3 trillion and the volume is still growing, while issuing green bonds by volume is the most popular
in US, China, and France. Green finance, born as a fresh economic approach in response to this
context (Liu et al., 2019), underscores the effective use of resources and the shifting of environmental
risks via interest transmission methods. These methods involve financial investments and funding
endeavors based on the principle of honoring sustainable development (Lee et al., 2021). In this
section we will define what is meant by green financial mechanisms, how they are used in practice and
the idea how they promote sustainable development.
1.4 Definition of green finance mechanisms
In this section I will define how green finance mechanisms work, how they are specified and for what
purpose they are established. The most direct approach would be to directly invest into green projects
such as renewable energies, but the market offers a broader range of green finance products. We can
think of products such as green bonds, which are aligned with ESG measures.
Numerous governments, such as Finland and the UK, have established precise objectives aiming to
eliminate carbon emissions. Achieving this goal proves challenging due to the inherent risks within
these projects. To streamline financing for such endeavors and bypass administrative obstacles, the
market has introduced green financial instruments. Among these, green bonds emerge as an alternative
to traditional bonds, serving as a debt mechanism aligned with Environmental, Social, and Governance
(ESG) goals (Bhutta et al., 2022).
Other products in green finance environment include renewable and sustainable equity such as
mentioned above, example of such investment might be direct investments into solar panels. Another
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popular option is investing in green mutual, which are set up in a same manner as regular mutual funds
with the distinction of investing into environmently friendly companies. Investor might also choose to
invest directly into green stocks. However, green finance does not only include investment
opportunities as it also includes products such as green mortgages offering attractive interest payments
(Jones, 2023). Lastly, I would like to mention green credit cards, which offer rewards for using green
financing.
1.5 Promotion of sustainable development
Many countries have set a goal in regards of their sustainable development, such as reducing carbon
dioxide emissions. For example, to avert a global environmental catastrophe, the Chinese government
has not only pledged earnestly to the international community regarding reaching a carbon peak and
achieving carbon neutrality (Xi, 2017) but has also exhibited resolute determination in realizing
sustainable development objectives by fostering the establishment of a low-carbon economy (Li et al.,
2018). Nevertheless, significant hurdles persist in the evolution and advancement of China's lowcarbon
economy. Some scholars argue that due to the influence of a planned economy era, limited
resources tend to channel or get assigned to the heavy industry sector, resulting in short-term
profitability (Abbasi et al., 2021). Yuan et al. (2020) suggest that the promotion of green finance or
investment in low-carbon projects can bridge the divide between private and social costs incurred by
polluting businesses by integrating environmental expenses. This, in turn, allows for a more efficient
allocation of resources between polluting and environmentally friendly industries, aligning with
societal and environmental demands. Additionally, they note that scaling up green financial resources
enhances the efficiency of capital movements over time and across regions, contributing to a decrease
in environmental pollution.
Bhutta et al. (2021) state: “financing is an essential factor to support sustainable development, and
there are some challenges to gather finances for environment-friendly projects. Green bonds are one
of the financial instruments to finance such task, and they provide capital to fund green projects. We
argue that the favorable regulatory environment and improvement in disclosure quality are essential
factors for the growth of green bonds.” Therefore, understanding how effectively green bonds
promote sustainable development is crucial, to understand the real effect of use of such green
instruments. The central focus revolves around the nature of projects funded via green bonds. Various
regulators globally establish distinct criteria that link financing to these specific green bonds
(Schumacher, 2020). Bhutta et al. (2021) found that green bonds are essential source of financing for
environmentally friendly projects and therefore being a crucial part of achieving the goals set up in the
Paris agreement. They also mention that there is a need of getting cheaper finance for sustainable
future, and to achieve that it is important to gain trust of stakeholders on the use od proceeds of green
bonds.
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Tolliver et al. (2019) researched further the use of green bonds for the Paris agreement and sustainable
development goals. They state that both the Paris agreement under the United Nations Framework
Convention on Climate Change and the SDGs of the United Nations Development Programme entail
substantial investments, which needs to be cost-efficient and ensure its longevity. They found that
publicly reported green bonds invested in by fifty-three organizations from 96 countries from 2008 to
2017 in their study, are associated with over 108 million tons of carbon dioxide equivalent in
greenhouse gas emissions reductions and growth of renewable energy capacity by 1500 gigawatts.
That is by allocating $58 billion in total over the span of 9 years. However, they also suggest
improving green bond post-issuance reporting and they also suggest how to apply future green bonds
in expanding Paris and SDG agendas.
Nguyen et al. (2022) researched the impact of green financing on sustainable development on multiple
cases in Vietnam. They found that the Covid-19 pandemic has caused uncertainties in most of the
business sectors, therefore commercial banks are less likely to finance uncertain projects even if they
were to positively impact the environment and prioritize projects with greater economic benefits to
cover for losses caused by the pandemic. Meaning that the sustainability is one of the goals of the
banks, but prioritization of projects with certain economic efficiency exists. Given the lack of
governmental supports they state the banks will play an important in the green finance initiative.
Green finance and transition to a low-carbon economy
As highlighted by Grossman (1995), economic actions exert influence on environmental progress via
scale, technique, and structural impacts. These effects serve as a theoretical foundation for
investigating how green finance functions in optimizing the allocation of capital, fostering
advancements in green technology, and driving improvements in industrial sectors. Such effects will
be investigated in the following chapters.
1.6 Low-carbon economy
Green finance significantly influences and moderates a low-carbon economy via its scale, technique,
and structural impacts. More precisely, it aids in building a low-carbon economy by rectifying capital
imbalances, boosting innovation in green technology, and refining industrial frameworks. The metric
of economic output per unit of carbon emissions, known as carbon productivity (CP) and initially
introduced by McKinsey consultancy in 2008, is regarded as a pivotal measure for quantifying a
society's and economy's low-carbon advancement (Liu & Zhang, 2021).
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1.7 Effect of green finance on low-carbon economy transition
Zhu et al. (2023) utilized a dataset covering China's provinces from 2005 to 2019 to explore how green
finance impacts the low-carbon economy. Their findings highlight three primary effects of green
finance—scale, technique, and structural—which collectively guide and moderate the low-carbon
economy, with scale having the most significant impact. Green finance influences economic output
and carbon emissions by optimizing capital allocation, fostering green technology innovation, and
improving industrial structure. While it fosters local low-carbon development and spatially spills over
to neighboring regions, its broader implementation is essential. Additionally, regional differences
affect the relationship between green finance and the low-carbon economy, where certain thresholds
determine its effectiveness in optimizing scale and structure while green technology consistently
contributes positively in the long term.
Monasterolo et al. (2022) investigated the role of green financial sector initiatives in the low-carbon
economy transition. They state that the effectiveness of green financial sector initiatives in supporting
reductions in greenhouse gas emissions relies on a country's commitment to a decarbonization
trajectory driven by economic policies. When a country credibly commits to a NetZero path by
phasing out fossil fuel subsidies and implementing measures aiding affected sectors, it justifies higher
capital costs for high carbon-emitting firms, aligning with financial assessments. Therefore, the
adjustments in capital costs and accessibility facilitated by green financial sector initiatives work best
when they complement comprehensive climate economic policies, ensuring sustainable transition
efforts over time. Conversely, without a credible commitment to a NetZero trajectory, green financial
sector initiatives effectiveness diminishes, as interest rates, capital costs, and risk assessments for lowcarbon
firms eventually revert to levels resembling those of high-carbon entities. Taking climate
change into consideration from the investors point of view and recognize that climate change
represents a new type of risk for finance and is recommended by Bertram et al. (2021) to assess this
new risk, including through climate stress tests, which has already been implemented by several
central banks. They also recommended investors to disclose climate risks on their balance sheets.
The green finance affects the transition to low-carbon economy through many channels as
stated by Monasterolo et el. (2022) – the price/interest rate channel, the quantity channel (lending to
the real economy and investors` portfolio rebalancing.
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Figure 1
Effects of policies rewarding green portfolios
Source: Monasterolo et al., 2022
In the graph above Monasterolo et al. (2022) show the effect of policies rewarding green portfolios.
The effect is not only direct in increasing banks liquidity, but the bank is motivated to hold
„greener“ portfolios in order to get more liquidity, therefore lending more to green subjects and
developing the green finance products further on. The end effect is the reduction of emissions.
1.8 Investments in green finance and its effects
Yang et al. (2022) analyzed the effect of renewable energy investments (REI) on carbon dioxide
emissions from two aspects of scale and structure on the data of thirteen countries, which invested
heavily in renewable energy systems over the last ten years. The effects of such investments are
presented in the picture bellow.
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Figure 2
Indirect effects of renewable energy investment scale on carbon dioxide emissions
Source: Yang et al., 2022
They found, that increasing REI scale can increase carbon dioxide emissions, specifically by
promoting growth and it can reduce carbon dioxide emissions by reducing energy intensity. They also
found that increasing investment in solar energy and bioenergy can increase carbon dioxide emissions,
while wind has the contrary effect. The increase of carbon dioxide emsissions due to increase of REI
scale is explained by increase in GDP caused by the investments. Even so, REI scale can restrain
carbon dioxide emissions through the “technique effect” mechanism. Therefore, governments should
continue to increase REI scale.
Conclusion
In the wake of 20th-century industrial development, the adverse environmental impacts necessitate
contemporary solutions focusing on sustainability across sectors, including finance. Sustainable
finance incorporated green finance mechanisms like renewable energy investments, green bonds,
green loans, or new green policies from countries, which are gaining momentum in the recent years.
This paper's objective was to explore the relationship between sustainable finance investments and the
shift in carbon emissions and broader environmental concerns as well as the effect of investments in
renewable energy.
Various research studies provide insights into the significance of sustainable finance, revealing its
diverse impacts. Further investigations highlight the financial implications of environmental
consciousness, shedding light on the influence of green finance instruments such as green bonds on
issuers' fundamental performances aligned with Environmental, Social, and Governance (ESG)
objectives.
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Key studies deal with the relationship between green finance mechanisms and the transition to a lowcarbon
economy. They emphasize the pivotal role of green finance in fostering green technology
innovation, and refining industrial structures, offering an accessible stream to finance green projects in
general. Understanding the effectiveness of green finance instruments like green bonds in promoting
sustainable development emerges as a critical aspect, with global regulators setting specific criteria
linking financing to these eco-friendly investments. While green bonds and green loans especially
after government support can generate attractive return on investment while taking the climate risk
into consideration.
Furthermore, empirical findings highlight the impacts of renewable energy investments on carbon
dioxide emissions, describing the relationship between the scale of REI and carbon emission
reductions. While REI scale may stimulate GDP growth, it can also indirectly suppress carbon dioxide
emissions through the technique effect, especially in wind energy investments. However, investments
in solar and bioenergy might have contrary effects on carbon dioxide emissions, indicating the
differences between different forms of renewable energy investments and their environmental
outcomes.
Overall, the synthesis of various research findings showcases the pivotal role of green finance in
steering global economies toward sustainability. As governments and financial institutions continue to
expand green finance mechanisms, these initiatives will play a crucial part in a transition to a lowcarbon
economy and mitigating environmental challenges. The synthesis of the perspectives presented
in this paper offers a comprehensive understanding of the dynamics between green finance,
environmental concerns, and the pursuit of a more environmentally conscious future.
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List of figures
Figure 1: Effects of policies rewarding green portfolios..........................................................................9
Figure 2: Indirect effects of renewable energy investment scale on carbon dioxide emissions……….10
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List of abbreviations
CAPM Capital Asset Pricing Model
CP Carbon Productivity
ESG Environmental, Social, Governance
GDP Gross Domestic Product
REI Renewable Energy Investments
SDG Sustainable Development Goals
UK United Kingdom
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Declaration of authorship
The role of green finance in supporting the low-carbon transition
I hereby declare that the present paper is entirely my own work and without the use of any
unauthorized assistance. Any content which has been taken verbatim or paraphrased from other
sources has been identified as such. This paper has not been submitted in any form whatsoever to an
examining body. Previously published work has been cited as such.
Vaduz, 29.11.2023 Bc. Matej Ingrst
29.11.2023
X Matej Ingrst
Matej Ingrst
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