Green Finance's contribution on the way to climate neutrality

The transformation required to achieve the climate targets is possible with technologies known today. However, it requires positive efforts and significant private and public investment – especially in climate-friendly technologies that reduce greenhouse gas emissions. Two decisive factors for private and commercial investments in climate protection measures are the financing options and conditions. The financial sector and especially Green Finance play an important role in directing capital flows towards sustainable investments and their financing.

For the Kreditanstalt für Wiederaufbau (KfW) Prognos quantifies the investment volume that is required for the transformation of the German economy by 2050 and therefore generally eligible for Green Financing – as well as identifying the relevant stakeholders and economic sectors where investments will be allocated.

Around 5 trillion Euro investment requirement, much of it in the transport sector

It is not easy to distinguish the green finance market in Germany, as the data situation is insufficient and definition issues are unresolved. It is therefore difficult to analyse this market. However, there is every indication that the current market volume is (too) small in relation to investment needs. Yet policymakers have now recognised the importance of green finance and are pushing its development.

Prognos estimates that climate protection investments totalling around 4.5 trillion Euro will be required over the period from 2020 to 2050 in order to reduce greenhouse gas emissions by 87 percent (compared to 1990). This corresponds to an average of about 153 billion Euro or 3.8 percent of GDP per year. Almost half of this will go into in the transport sector (48 %). The other half will be directed to the energy sector (19 %), while the remainder is divided among the other sectors industry and household sectors (14 % each) and commerce (5 %).

Achieving complete climate neutrality, i.e., reducing greenhouse gas emissions by 100 percent in all sectors, will require additional climate protection investments of an estimated 506 billion euros by 2050 (upper limit). Thus, total climate protection investments required until 2050 amount to around 5.0 trillion euros.

The climate protection investments calculated represent practically everything that needs to be financed for the transformation and is thus in principle eligible for green finance. Many of these investments would have been made anyway by 2050, but are now directed into climate-friendly objects, e.g., the purchase of new cars (now electric cars). This issue is reflected by the share of climate protection related investments in total investments: Across all four sectors mentioned above, the share of climate-related investments in total investments is around 23 percent. However, the estimates are fraught with uncertainty due to methodological and data limitations as well as due to definitional questions as to which investments are classified as "green".

Government should stimulate investments

Due to investment rationalities of the stakeholders the necessary investments are often not made to the necessary extent and within the adequate timeframe, or in some cases not made at all. The government is needed to stimulate investment: On the one hand, the public sector should act as a role model and lead the way by conducting the necessary investments (e.g., energy-efficient renovation of public buildings, electrification conversion of the public vehicle fleet). On the other hand, the government must set a favourable framework for the transformation process (e.g., with regard to providing flexibility potentials in the energy supply or infrastructure development). This also includes the creation of favourable financing conditions – especially with regard to Green Finance.

This encompasses, among other things, funding instruments such as reduced interest rates, subsidies or liability exemptions to investment constraints. However, due to the specificity of the investment objects as well as due to the heterogeneity of the stakeholders (family businesses, corporations, private individuals), a uniform approach does not seem appropriate.

Crisis as an opportunity - setting the course for green finance

Although the Corona crisis pushed Germany into a recession likely to become the second worst economic slump of the post-war period, longer-term changes in investment needs and investment spending are not foreseeable. Instead, the stimulus package by EU and Germany, the persistently low interest rates and increased liquidity provision by the ECB are rather likely to continue to ensure attractive financing conditions for investments. The German Sustainable Finance Strategy and further political projects such as the development of a European taxonomy for green activities and financial products as well as considerations by the ECB to deviate from the principle of market neutrality in favour of green bonds could further drive the development of the green finance market.

Overall, the strong increase in the volume of climate investments in the upcoming years and decades indicates that in the future, significantly larger sums will need to be available for financing green investments than today. The financial sector – especially in the area of Green Finance –will play an important role in steering capital flows towards financing “green” investments. The current economic crisis can therefore also be seen as a chance for the sector to develop “green” products and establish Germany as a (leading) location for Green Finance.

To the study (website KfW, in German)

To the press release (website KfW, in German)

Authors: Dr Almut Kirchner, Dr Heiko Burret, Sven Kreidelmeyer, Thorsten Spillmann, Jakob Ambros, Jan Limbers, Andreas Brutsche (all Prognos) Dr Martin Granzow (Nextra Consulting) und Rolf D. Häßler (NKI)