The unprecedented global goals for climate change mitigation and adaptation established by the Paris Agreement in December 2015 will be pursued largely through domestic plans submitted by the 197 participating countries. These plans, known as Nationally Determined Contributions (NDCs), outline how each country will fight and adapt to climate change, including key goals and priority sectors.
Thirty-two of 33 countries in Latin America and the Caribbean (LAC), representing more than 99 percent of LAC emissions, signed the Paris Agreement, and 25 countries, representing more than 77 percent of LAC emissions, have ratified it so far (WRI, 2016a; UNFCCC, 2017). Implementing NDCs will require large amounts of investment, and the Paris Agreement recognized the need to mobilize flows of finance toward low emission and climate-resilient development. Climate investment needs in LAC are forecast to rise to around $80 billion a year in the next decade—almost three times what the region invests today. As part of these efforts, at its annual meeting, the IDB Group committed to focus on projects that will help LAC countries implement their commitments to reduce greenhouse gas (GHG) emissions and to build resilience to climate change, and pledged to increase the share of climate finance to 30 percent of the portfolio by 2020.
This study examines 12 national development banks (NDBs) and other domestic development finance institutions (DFIs) in Brazil, Mexico, and Chile to explore their current and potential roles in financing NDC implementation. These three countries represent more than 56 percent of LAC emissions. Domestic DFIs occupy a unique position in development landscapes, as connectors of international finance, domestic governments, and local private sector actors. They have the institutional support from governments and nuanced understanding of local sectors needed to provide finance and technical support and to mobilize climate investments that can help to meet NDC objectives.
This is the first study of its kind to focus on what domestic DFIs in three large LAC countries are doing to mobilize investments for NDCs, the barriers they face in increasing climate finance, and opportunities they have to overcome them. It builds on and complements previous research from the IDB and the Climate Policy Initiative (CPI) on the roles of NDBs in catalyzing climate finance (Smallridge, Buchner, Trabacchi, et al., 2013), as well as analysis from the International Finance Corporation (IFC) on NDC financing needs in LAC (IFC, 2016a).
The Investment Gap
The shortfall between current climate finance flows and identified NDC investment needs in these three countries is large. Even with conservative estimates of NDC financing needs—which cover only a limited fraction of climate change mitigation objectives in the renewable energy, industrial energy efficiency, and infrastructure sectors—this gap is billions of dollars per year in Chile, tens of billions annually in Brazil and Mexico, and is particularly significant in the energy efficiency and urban infrastructure sectors (IFC, 2016a, b; Buchner, Mazza, and Falzon, 2016).
The gap between tracked current adaptation spending and NDC adaptation objectives in these three countries is likely to be significant. Adaptation goals form an important part of all three countries’ NDCs but are often high-level goals and are not yet quantitatively defined. So far, there are no reliable estimates of the financing needs to achieve these goals. The challenges to domestic DFIs in identifying and structuring adaptation projects are reflected in a lack of investment—less than 2 percent of their climate finance flows went toward adaptation.
Despite these challenges, surveyed domestic DFIs made more than US$11 billion in climate finance commitments in 2015. The vast majority of this financing (98 percent) went toward mitigation projects. Virtually all tracked climate financing came in the form of concessional or market-rate lending, most financing went to private-sector recipients (85 percent), and the predominant sector for climate financing investment was renewable energy (43 percent).
Opportunities to Support Domestic DFIs in Increasing Climate Financing
- Develop appropriate investment frameworks and translate NDCs into bankable investment plans. National and multilateral development banks (MDBs) can have a critical role in supporting governments in translating NDC aspirational goals into tangible investment objectives and, accordingly, develop an appropriate investment framework that creates a bankable deal flow, especially in areas such as resilient infrastructure and transport where business models are not yet established. Brazil’s, Mexico’s, and Chile’s current NDCs do not specify the roles of domestic DFIs in implementation, and institutions have expressed a desire for greater guidance from governments on their roles and greater involvement in the planning process. Governments can use the capacity and experience of NDBs in both the NDC update process and in ongoing efforts to create national climate financing strategies and plans, ensuring that domestic DFIs’ mandates and capabilities are well aligned with well-defined, quantitative NDC goals.
- Incorporate comprehensive climate finance tracking throughout portfolios. Governments and MDBs can work alongside DFIs to mainstream tracking of climate finance throughout portfolios. Most surveyed institutions do not systematically track climate finance across their portfolios, citing particular difficulties with adaptation investments. Support for tracking would help them identify climaterelevant projects in sectors that they are less familiar with and to measure progress over time as NDC goals are further defined.
- Enhance understanding of the risks and financial structuring of different types of climate financing projects, particularly for adaptation, energy efficiency, and urban infrastructure projects. Surveyed institutions cited difficulties in financially structuring climate relevant projects as among the most common barriers they face. Their perception that climate- relevant projects offer poor risk-adjusted returns was another key barrier revealed by the survey. National and multilateral development banks can work together to employ risk mitigation instruments such as insurance and guarantees to improve perceived risk-adjusted returns of climate projects and drive investment to fill key NDC financing gap sectors while demonstrating the viability of these investments and building the technical capacities of NDBs. (Institutional and individual capacity building reduce perceived risks.)
- Develop new climate finance instruments. Bilateral and multilateral development institutions can partner with domestic DFIs and private sector actors to explore, develop, and pilot the innovative financial instruments that will allow them to scale up investments in climate finance. This effort can build on public–private partnership models that blend concessional and commercial investment, such as the Global Innovation Lab for Climate Finance, but focus on developing financing vehicles specific to individual countries and NDC sector goals, for which there are yet no viable private investments (see Box 6 for an example). Also, NDBs could consider going one step further and putting in place climate or environmental strategies and action plans and having a better and more consistent disclosure of what NDB finance is needed.
- Pursue new forms of concessional and grant financing while building technical capacities. MDBs can support domestic DFIs in pursuing new forms of concessional and grant financing from major climate funds. Insufficient access to long-term or low-cost financing was among the most commonly cited financial barriers to greater climate finance investment. Partnerships with MDBs, where the MDB initially acts as an intermediary accredited entity to Climate Funds, can help NDBs build the kinds of project track records that are needed for eventual accreditation with an entity like the Green Climate Fund (GCF). Grant and concessional financing can also help domestic DFIs explore climate finance sectors where they still need to grow the institutional capacities in order to fulfill NDC objectives. This financing can also be used to help create local markets and to build awareness of the business case for climate-relevant investments among financial institutions, local manufacturers and suppliers, consumers, and others.