China Report: A Framework for Green Finance

The existence of externalities has made it hard to quantify the intrinsic value of the “green mountains and blue water” of the natural environment. This has led to a dysfunction in traditional financial markets, which are delivering an insufficient supply of capital for green development and an oversupply of capital for highly polluting activities.
As a new financial development paradigm, green finance seeks to internalize these externalities in financial decision making. Systems for allocating and trading emission rights are a critical foundation, creating price signals that transmit information about scarcity and the value of environmental assets. These are complemented by other government policies focusing on enhancing risk assessment and information analysis, and providing targeted financial support for green investment through monetary and fiscal support.

This paper lays out a framework for considering the design of a green financial system in China, encompassing:

1. The policy system for internalizing environmental costs and benefits.
2. The financial actors, including the policy-based financial institutions (FIs), commercial FIs and Internet-based FIs that respond to these signals.
3. The financial products, such as green credit, green insurance, green bonds and green venture capital funds, which serve as instruments for managing risk and intermediating capital.

[NB: This report is one chapter in the book Greening China’s Financial System]