This presents a challenge. China, which is not a member of the Paris Club, has emerged as a source of more financing for poor countries than all other creditor nations combined. Some wonder whether China’s intentions are altogether benign; loans granted under China’s Belt and Road Initiative have been criticized in some corners as predatory, with the ultimate objective of gaining control over ports or commodities.

But China has stepped in because Western nations have failed to provide synchronized relief to poorer economies. The recent tone from the U.S. has not been positive towards these resolutions, but President Biden has indicated his willingness to work with global institutions on this front. One angle being promoted by Washington is providing “green debt relief” to developing countries ready to make climate commitments. 

The U.S. stance opposing additional allocation of the IMF’s Special Drawing Rights (SDRs) could also change. SDRs are supplementary foreign reserve assets allocated in line with nations’ share of the world economy, which would help provide much-needed liquidity to countries with tight public finances.

All Stakeholders Must Cooperate To Find A Sustainable Solution To Unsustainable EM Debt.
Developing countries are already suffering from the damage to public health caused by Covid-19. A debt crisis on top of that would be catastrophic and could trigger unrest and political instability. Historical episodes, like the 1997 Asian financial crisis, show that a debt crisis even in a small nation can spiral into a significant event around the world, leading to losses for financial institutions and potential instability within financial systems. Hence, strong multilateral cooperation will have benefits beyond the financially vulnerable nations receiving aid.

Covid-19 might be the mother of all crises, but in times like these, necessity can be the mother of invention. With that thought in mind, we are hoping that developing countries and the organizations that represent them will come together to provide a sustainable, durable solution to the debt burden of developing economies. It isn’t a matter of throwing good money after bad; it’s an investment aimed at avoiding damaging long-term economic and social damage from this once-in-a-century calamity.

Green Shoots
In December, the Federal Reserve announced it had joined the Network of Central Banks and Supervisors for Greening the Financial System (NGFS). The Fed was one of the last major central banks to become part of NGFS, which now has 83 members.

While banking is not known to be a polluting or energy-intensive industry, the risks associated with climate change are requiring more attention from financial companies. As an example, increasingly frequent bouts of severe weather, caused by warming air and seas, can threaten waterfront properties and loans secured by them. Some borrowers in high-emission industries may face new regulations that could impact their ability to repay loans. Climate extremes may eventually make commerce almost impossible to conduct in some places, placing regional lenders in peril.

Central banks are not prescriptive as to which loans banks should fund or decline, but they do have a vested interest in ensuring the health of the financial sector. Nearly all central banks’ remits include a mention of stability. Some, like the Federal Reserve, have a narrow scope of price stability (or managing inflation), while others have a broader mandate of supporting sustainability or furthering domestic agendas. As a changing climate may reduce stability in many respects, central banks must consider how the financial sector is preparing for this possibility.

NGFS is an international working group for central banks to cooperate in addressing the challenges of climate change. Its work is organized into five streams:

• Microprudential / supervision guides practices for integrating climate risks into bank regulation.
• Macrofinancial develops climate scenarios for bank stress tests and provides guidance on integrating climate risk analysis into banks’ regulatory reporting.
• Scaling up green finance promotes the adoption of sustainable principles in central banks’ investments.
• Bridging data gaps and Research coordinate data and research publications across NGFS workstreams.

Climate Change Is Too Large A Risk For Banks To Ignore.
NGFS membership is voluntary, and its role is only advisory. NGFS members can share and build on each other’s experiences to find better ways to address the consequences of climate change. 

Thus far, the Bank of England (BoE) leads the world in this arena. It was among the first to require its member banks to perform climate stress tests. After postponing the planned launch in 2020 due to the pandemic, this year’s tests will include climate risks for the first time. Bodies like NGFS will build on these exercises to develop best practices for climate stress testing.