Regulatory authorities in China will review banks’ green finance performance
FS-UNEP Centre / 12 August 2020
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Sustainable Finance Researcher
Menglu Neupert-Zhuang is a member of the research group at the FS-UNEP Collaborating Centre for Climate and Sustainable Energy Finance. Her research interests are in behavioural and environmental economics. She is passionate about studying financial decision-making in the context of redirecting the economy and society towards sustainability. Her impact-oriented research contributes to the latest policy debates in sustainable finance.

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Sustainable finance is an important topic for regulators in China. Chinese banks will soon be subject to green finance performance review on a quarterly basis. The first review is planned for the fourth quarter of 2020. The People’s Bank of China (the central bank of China) published a consultation document:  Green Finance Performance Evaluation Scheme for Banks (《银行业存款类金融机构绿色金融业绩评价方案(征求意见稿)》, July 2020). The consultation document describes the procedures and metrics based on which the banks will be evaluated. Under this regulatory pressure, Chinese banks are likely to recognise the urgency in taking some real actions in green finance.

History of green finance policies in China

China launched the Green Credit Policy in 2007, encouraging banks to lend more to green projects and less to highly polluting ones. The Green Credit Guideline followed in 2012, instructing banks on addressing green finance at top management level and integrating environmental and social considerations into the lending process cycle. However, Zhang, Yang & Bi (2011)’s research shows that the green credit policy was not fully implemented. At that time, there lacks concrete metrics and plans for external evaluation by regulatory authorities. The newly released consultation document fills this gap.

Green finance evaluation metrics

In China, green finance refers to economic activities in support of environmental improvement, combating climate change, as well as conservation and efficient use of resources. While there is EU taxonomy to categorise economic activities into sustainable and non-sustainable, in China there is the Green Industry Guidance Catalogue (《绿色产业指导目录(2019年版)》), which lists which activities are considered green.

In the consultation document, “green finance” includes but is not limited to green loans, green securities, green equity investment, green leasing, and green trust in the banking businesses. The document indicates that the evaluation will focus on green loans and securities at first. The central bank will announce the decision, should it decide to include other financing types in the review in the future.

The green finance performance evaluation is based on 80% quantitative assessment and 20% qualitative assessment. Four assessment indicators are employed in the quantitative part: the proportion of green finance balance in bank’s total business mix, the proportion of green finance balance in the total green finance balance of all banks participating the evaluation, the year‐on‐year growth of green finance balance, and the share of risk exposure. Each quantitative indicator is evaluated based on two benchmarks. The first benchmark checks the bank’s green finance development over the last three quarters. The second benchmark compares the bank’s performance with its peers in the current quarter. Notably, the peer performance comparison has a higher weight.

External regulatory authorities will conduct the qualitative evaluation based on three assessment indicators: the bank’s implementation status of national and local green finance policies (30%), implementation status of the institution’s own green finance development strategies (40%), and status of financial support for the development of green industries (30%). The scoring rules will take a wide range of factors into consideration, for instance the bank’s green finance status with regard to risk management, loan approval, product innovation, scale of funds for green projects, interest rates, and post-loan management.

Potential consequences for lending practices of Chinese banks

The evaluation metrics make clear of what type of results the regulatory authority is interested in. The banks are likely to act accordingly, in particular targeting how to achieve better results. It can be speculated that the Chinese banks will strive to fair well in the peer comparison by increasing green finance share.

The choice of metrics and the way they are designed suggest that they can be used to create incentives for green lending and monitor credit risks at the same time. For instance, if the bank unselectively lends to green projects without risk-return considerations and the loan quality worsens, this will be reflected in the risk exposure indicator in the quantitative assessment. Furthermore, with the help of metrics, both banks with improvement potential and the leading banks can be rewarded. Banks with predominantly „brown” loan portfolios could receive a relatively good score for the indicator that measures their own development, if improvements are made. Banks with largely “green” loan portfolios, in contrast, could be rewarded on the indicator that measures the green share compared to other banks.

The central bank plans to verify the indicator data and materials submitted by the banks from time to time to prevent fraudulent. It will also integrate the green finance review results into the rating of supervised Chinese banks – this will likely incentivize the banks to take the evaluation more seriously. However, how well the monitoring and control will work depends on if there are loopholes for the banks to take, e.g. whether the verification review is randomly selected and whether the punishment for fraudulent is severe enough to prevent similar actions.

In the years to come, it will be exciting to observe the implementation of the novel review process, the reactions from the Chinese banks, and the assessment results of green finance performance.