How can the Western Balkans boost green finance?

The countries of the Western Balkans are highly vulnerable to costly natural disasters such as floods, wildfires, earthquakes and droughts, and climate change is only expected to exacerbate the frequency and intensity of weather-related hazards. Grappling with climate change also brings its own substantial challenges, as transitioning towards less carbon-intensive economic activities can lead to transformation in some economic sectors that may require new investments.  

The region needs to remain vigilant about the impact of climate change on its financial sectors. Both the physical and transition-related risks of climate change can cause revenue losses, heightened credit risks and lower funding sources from customers in affected sectors such as mining, energy or agriculture. At the same time, economic shocks such as the COVID-19 pandemic and the fallout of Russia’s invasion of Ukraine have depleted fiscal space across the Western Balkans. With limited public sector resources for investment in climate adaptation and mitigation and shallow capital markets, domestic banking sectors are seen as key players to mobilize private funds for green investments.  

The Western Balkans still has some way to go in greening finance  

Green finance—whereby financial institutions' lending and investments contribute to climate mitigation, climate adaption and resilience and mitigating environment risks—is critical, but progress remains at the initial stages in the Western Balkans. Despite the significant physical and transition risks as well as their proximity and economic linkages to the European market, governments across the region lack comprehensive strategies and roadmaps to tackle climate and environmental risks. Green taxonomies, a key enabler for the creation of a green loan and bond market, are yet to be developed, while disclosure requirements for large corporates and other economic agents have not been introduced. And banking supervisors are only beginning to take a closer look at the exposure of financial institutions to climate risks.

The Western Balkan economies need to increase their efforts to green the financial sector.  An initial step would be to address misalignment of fiscal, economic and environmental policies. For example, public subsidies are still being offered to economic activities with a high carbon footprint, and effective carbon taxation is largely missing. Uncertainty on long-term government policies may also inhibit the development of sustainable economic projects, while data gaps can limit the capacity of financial institutions to identify and originate green assets and manage climate risks. Furthermore, as outlined in a recent World Bank toolkit, the high upfront financing costs, transactions costs, lack of track-record of new technologies, and long payback periods for some green projects could increase the real and perceived riskiness of green projects overall. These factors can indirectly influence investors’ appetite, negatively impacting investment and lending decisions.

Ways forward on green finance in the Western Balkans

To green the region’s financial sector, governments in the Western Balkans need to consider:

Prioritizing sustainability strategies and green taxonomies

Central banks and banking supervisors in the region are taking their first steps towards preparing and approving sustainability strategies and roadmaps. These strategies are being developed by the central banks in Albania, Kosovo, Montenegro and North Macedonia, and the banking agencies in Bosnia and Herzegovina.

In parallel, ministries of finance should take the initiative for developing green taxonomies, which are key to defining green investment and finance that will enable banks, insurers and capital market institutions to develop new instruments, central banks and supervisors to rely on standardized and comparable data, and corporates to make appropriate disclosures.  

Promoting prudential management of climate and environment risks

To support prudential management of climate-related and environment risks, financial authorities need to develop an approach to climate and environment risk assessment. Regulators should have a comprehensive understanding of the situation of the banking sector’s climate and environmental risks. Albania, Bosnia and Herzegovina, Kosovo and North Macedonia are in the initial stages of issuing surveys of environmental risks to commercial banks, while Bosnia and Herzegovina and North Macedonia have begun drafting a Strategy for Green Finance.

Developing green finance instruments

Western Balkan governments could explore opportunities to issue sovereign green and blue bonds; Serbia issued sovereign green bonds in 2021. To help mobilize private capital toward climate mitigation and adaptation, financial authorities could cooperate with corporates and financial market participants to develop green finance guidelines for issuances as well as establish minimum entry requirements for independent assessors, ratings, or verification services to ensure quality external reviews and enhance comparability. Because the corporate bond market is nascent amongst the Western Balkan financial sector, governments may want to consider introducing incentive mechanisms to reduce transaction costs such as for external reviews of green bonds. Moreover, working with institutional investors to integrate sustainability considerations into the investment decision-making process could foster demand for green assets.

Ministries of finance may also explore options to introduce industry-level risk pooling mechanisms for natural disaster insurance like agriculture insurance. Existing national development banks and credit guarantee schemes could also play a leading role in greening the financial sector.

Finally, for capacity building and knowledge exchange purposes, Western Balkan governments might also consider joining international platforms such as the Coalition of Finance Ministers for Climate Action.