Policy Brief: Green Credit in China

By Kun Li and Jingyi Zhu

Introduction

 The Green Credit Policy was introduced in 2007 to support sustainable development efforts and reduce the impact of economic activities on the environment in China. It requires that banks in China incorporate environmental factors into their lending decisions and promote green lending practices. The policy includes guidelines for assessing the environmental impact of lending and requires banks to establish an internal management system for evaluating the environmental risks and opportunities associated with lending. The policy also encourages banks to offer preferential interest rates and other favorable terms to borrowers who engage in environmentally friendly practices (Qian, 2016).

 Though proven to be effective in many cases, it is exposed to potential risks, including green washing, and environmental disaster-related risks, despite the same risks as traditional finance. To solve these problems, the policy brief provides several possible solutions.

Strengths of Green Credit Policy

Given the effects imposed on both borrowers and lenders, green credit system development may considerably do good to the environment. As lenders, considering their interests and social responsibilities, banks will control the number and quality of loans to enterprises to avoid bearing the financial risks generated from environmental factors transferred by enterprises. When applying green credit to projects, rigorous evaluation is carried out, thereby reducing the availability of loans for pollution-prone projects (Yu, 2023).

For firms or individuals who borrow a loan, the policy would have effects on corporate environmental concerns. Generally speaking, the more enterprises pay attention to the environment, the more likely they are to fulfill environmental and social responsibilities, and the more likely they are to carry out green innovation activities. Especially industries with high pollution and high energy consumption are forced to carry out technological transformation and upgrade to better finance.

Weaknesses of Green Credit Policy

Adverse aspects have also occurred in relation to China's Green Credit Policy, which is as follows.

Green-washing: Some companies and even local governments may try to take advantage of the Green Credit Policy by falsely claiming to be environmentally friendly to receive preferential lending terms (Tang et al., 2020), which may undermine the effectiveness of the policy and mismatch the capital by allowing companies not truly committed to environmental sustainability to benefit from the program. Meanwhile, under the performance review pressure from the central government, for instance, some local governments in China use the Green Credit Policy to attract investment, rather than as a tool for promoting environmental sustainability (Huang&Chu, 2020). In other words, these projects are approved without sufficient environmental oversight or due diligence. Also, there may be misleading information leaked from enterprises to show their environmental value, which will lead to inflated stock prices, and it is especially serious for those non-state enterprise (Yang et al., 2020).

Default Risk: There is a risk that some green projects may not be financially viable or may fail to generate the expected returns and affect the liquidity of companies and result in the failure to pay back bank loans (Cui et al., 2018). If banks lend to these projects without proper due diligence, it could result in financial losses for the banks and ultimately, the economy. For example, in 2019, it was reported that many of the wind power projects produced less energy than expected, leading to financial losses for the companies involved and raising questions about the viability of the projects.

Recommendations

As the CBRC Green Credit Guidelines(2012) suggested, China has already established a monitoring process, introducing Banking financial institutions to evaluate the proposed credit to customers before giving the loans, and if necessary, banks should ask for support from qualified and independent third parties and relevant authorities. Regularly there are inspections from higher levels. Banks are also given the right to stop funding unqualified projects in a timely manner.

But in such a system of monitoring, local governments have to experience pressure from central governments that ask for economic performance appraisal, which will offset the micro-policy effect of the central environmental protection inspectorate, that is, the higher pressure of economic performance appraisal will weaken the inhibitory effect of the central environmental protection inspectorate on enterprise greenwashing. This kind of supervision is time-sensitive, once the central government relaxes or suspends inspections, then greenwashing will recur. Therefore, we believe that the relevant government assessment mechanism should be improved. In the inspection process, in addition to adhering to the accountability mechanism, it is also necessary to take into account the fault tolerance and exemption mechanism, to prevent excessive assessment pressure from causing local governments to release green credit at will. As for the issue of timeliness, we believe that we can mobilize social forces such as the media to strengthen social supervision as a new supervisory force to act as a check and balance to enterprises and the government.

Moreover, capacity and knowledge among government officials, financial institutions, and the private sector should be built to ensure the effective implementation of the Green Credit Policy(2016).Specifically, commercial banks are supposed to improve the selection criteria for their staff and strengthen staff training in the green credit department, which has not formed comprehensive guidelines widely. It may be wise to set aside a portion of the bank's revenue as a fund for green education, and incorporate knowledge of green credit into the professional training system, such as environmental risks management and discriminating and selecting compliant projects.

To avoid default risks, we also suggest establishing a complete carbon database, that records their interest and carbon emissions from their production process, making sure a certain fraction of their revenues come from the financed green projects and introducing institutions similar to financial audit departments to audit the annual financial reports and carbon data of green creditors to check whether the information disclosed is true. This can reflect the true value and green level of enterprises, disclose correct environmental information, prevent enterprises from falsifying information to obtain green credit, reduce the information asymmetry of the capital market, and mitigate market risks.

Conclusion

While several problems exist to the Credit Policy, the value of the Green Credit Policy is not to be undermined, as it is still an effective model to reduce impact of economic activities on an environmental scale. These concerns also highlight that policymakers and regulators need to pay continued attention to its effective usage both in the good and bad light. By addressing the downsides of the policy, and potentially improving it, China may progress toward a more sustainable and environmentally friendly economy.

References

Qian,L. (2016). Green credit system of China's banking industry.China Finance. No.844(22):70-71.

Yu,B. (2023). How Does Green Credit Policy Promote Green Innovation of Enterprises?. Discussion on Modern Economy. 02: 45–55. https://doi.org/10.13891.

Tang, Y., Yang, R., Chen, Y., Du, M., Yang, Y., & Miao, X. (2020). Greenwashing of local government: The human-caused risks in the process of environmental information disclosure in China. Sustainability, 12(16), 6329. https://doi.org/10.3390/su12166329

HUANG Rongbing & CHU Fang. (2023). Central environmental protection inspection, performance appraisal pressure and enterprise "greenwashing". Journal of China University of Geosciences (Social Science Edition)(01),70-86. doi:10.16493/j.cnki.42-1627/c.20221124.001.

Yang, Y., Wen, J. and Li, Y. (2020) “The impact of environmental information disclosure on the firm value of listed manufacturing firms: Evidence from China,” International Journal of Environmental Research and Public Health, 17(3), p. 916. Available at: https://doi.org/10.3390/ijerph17030916.

Cui, Y., Geobey, S., Weber, O., & Lin, H. (2018). The impact of green lending on credit risk in China. Sustainability, 10(6), 2008. https://doi.org/10.3390/su10062008

Green Credit Guidelines, CBRC.(2012) https://www.amac.org.cn/

Guidelines for Establishing the Green Financial System. (2016, September 3). Research Center for Climate and Energy Finance, CUFE. http://rccef.cufe.edu.cn/info/1002/1385.htm