IMF: Taste-Based Investing, Government Policies, and Competition in Financial Intermediation
SDG 7: Affordable and Clean Energy | SDG 13: Climate Action | SDG 17: Partnerships for the Goals
Ministry of Finance | Ministry of Environment, Forest and Climate Change (MoEFCC) | Ministry of New and Renewable Energy (MNRE)
The International Monetary Fund (IMF) paper titled Taste-based Investing, Government Policies and Competition in Financial Intermediation develops a theoretical framework to analyze how the non-pecuniary “tastes” of investors—such as preferences for ethical, environmental, or social outcomes—are transmitted to aggregate investment through the market structure of financial intermediation. The study highlights that the effectiveness of these tastes in shifting capital allocation, particularly in the context of green finance, depends critically on whether they originate from households (ultimate investors) or from the financial intermediaries themselves.
Market Structure and Tastes The paper reveals a fundamental interaction between the degree of competition in financial markets and the source of investing tastes:
Households’ Tastes: In highly competitive financial systems, strong competition acts as a “pass-through” mechanism, forcing intermediaries to cater to investor preferences for amenity assets (e.g., green investments) to retain funding.
Intermediaries’ Tastes: Conversely, when intermediaries possess their own tastes for specific investments, these are often “arbitraged away” in highly competitive markets as firms are pressured to hold return-maximizing portfolios. Intermediaries’ own motives are only effective in shifting capital when they enjoy some degree of market power.
Market Segmentation: The endogenous sorting of households into specialized intermediaries based on their preferences creates “segmenting equilibria,” which generally increases market power and alters the aggregate pass-through of tastes.
Policy Effectiveness Across Competitive Landscapes The logic of private tastes extends directly to government interventions. The study finds that the optimal mix of financial-sector policies depends on the specific market structure of an economy:
Household-Centric Policies: Tax rebates or incentives given to households based on their intermediaries’ portfolios are most effective in competitive environments (e.g., the U.S. or Japan).
Intermediary-Centric Policies: Tools like portfolio-based capital requirements or differentiated taxes on bank profits are more impactful in concentrated banking systems where intermediaries have higher market power (e.g., several European countries).
What is the “Amenity Premium” (Greenium) in the context of this study? The amenity premium, often referred to as a “greenium” in climate finance, is the difference between the required rates of return on normal (often “brown” or carbon-intensive) assets and amenity (often “green”) assets. It acts similarly to a corrective Pigouvian tax by discouraging investment in technologies that generate negative externalities. The study calibrates that an amenity premium of approximately 10% would be required to implement the same capital allocation as a $100 carbon price—a figure substantially larger than what is currently observed in global markets.
Policy Relevance
The IMF framework offers strategic insights for India’s Ministry of Finance and the RBI as they navigate the transition toward mandatory green finance.
Regulator-Led Green Transition: In India’s banking sector, where major banks hold significant market shares, the paper suggests that intermediary-centric policies—such as the RBI’s Green Deposits Framework—will be more effective than relying solely on household preferences.
Effective Policy Mix: Implementing “green capital requirements” for Indian lenders is likely to have a higher pass-through into real investment than household tax rebates. This validates the RBI’s focus on integrating climate risk into the Internal Capital Adequacy Assessment Process (ICAEP).
Bridging the Greenium Gap: The study’s finding that a ~10% amenity premium is needed for a $100 carbon tax equivalent highlights the necessity for government-led “Disciplined” financial incentives to bridge the current gap in market returns for green projects.
Strategic Policy Timing: The warning that competitive markets can “arbitrage away” green tastes explains the importance of establishing strong institutional standards before full market liberalization to prevent “greenwashing”.
Follow the full paper here: Taste-based Investing, Government Policies and Competition in Financial Intermediation