IMF Working Paper on Green Financial Policies: Balancing Capital Access with Emission Efficiency
SDG 7: Affordable and Clean Energy | SDG 8: Decent Work and Economic Growth | SDG 13: Climate Action
Ministry of Finance | Reserve Bank of India (RBI) | SEBI | Ministry of Environment, Forest and Climate Change (MoEFCC)
The IMF Working Paper titled ‘Financial Constraints and the Effectiveness of Green Financial Policies’ highlights that financial constraints significantly hinder the adoption of cleaner technologies, particularly for firms operating close to their borrowing capacity. While broad relaxations of financial constraints can boost GDP, they often lead to higher total emissions by increasing capital and energy intensity. To address this, governments are increasingly utilizing Green Credit Policies—targeted financial interventions such as public loans or guarantees—to steer investment toward “frontier” (most efficient) technologies that can simultaneously lower emissions and raise output.
Key findings and model implications include:
The Productivity-Greenness Link: Firms with higher net worth are more productive and emit less relative to their value added.
Pecking Order of Vintages: Constrained firms often settle for “dirtier” or older capital to maintain operational scale rather than adopting high-quality, cleaner technologies.
Free Permits as a Buffer: Allocating free emissions permits under a cap-and-trade system can offset the output costs of carbon pricing, helping firms grow out of borrowing constraints faster.
Strategic Targeting: Green credit policies are only effective when strictly focused on frontier technologies; extending coverage to less efficient vintages can result in a net increase in total emissions.
What are “Green Credit Policies” in the context of climate finance? Green Credit Policies are financial-sector interventions designed to alleviate financial frictions and steer credit toward sustainable investments. These include public lending, guarantees, interest rate subsidies, and adjustments to collateral or risk-weighting rules. When precisely targeted at frontier green technologies, these policies function through a redistribution channel that allows financially constrained firms to bypass the traditional “pecking order” of investment and adopt cleaner capital vintages earlier than they otherwise would.
Policy Relevance
The study offers a strategic roadmap for India’s evolving green finance ecosystem:
Empowering MSMEs: Since many Indian small and medium enterprises (SMEs) face binding financial constraints, they are naturally biased toward older, high-emission capital. Targeted credit guarantees are essential to help these firms leapfrog to “frontier” technologies like industrial heat pumps or advanced renewable systems.
Refining Green Lending: For green lending to deliver net emissions reductions, credit eligibility must be tightly defined. Broad “green” classifications risk financing scale expansion of energy-intensive activity alongside efficiency gains. The implication for Reserve Bank of India is a need for technology-specific or outcome-linked criteria within priority and green lending frameworks, aligned with verifiable emissions performance..
Market Integration: As India explores its own carbon pricing mechanisms, the paper highlights that complementing carbon markets with financial policies, such as free permit allocations, can achieve significant emission reductions without reducing output.
Regulatory Clarity: A clear and enforceable climate taxonomy is essential to prevent “greenwashing” and misallocation of capital. For the Ministry of Finance, the priority is ensuring that taxonomy definitions distinguish transformational technologies and pathways from marginal efficiency improvements, with transparent thresholds and review mechanisms aligned to India’s 2070 Net Zero trajectory.
Follow the full paper here: Financial Constraints and the Effectiveness of Green Financial Policies