Climate Transition Risk and Development Finance: A Carbon Risk Assessment of China’s Overseas Energy Portfolios

The role of development finance institutions (DFIs) in low-income and emerging countries is fundamental to providing long-term capital for investments in climate mitigation and adaptation. There is growing awareness among DFIs of the need to factor climate change into the financial risk assessment of their portfolios and the importance of assessing the opportunities generated by their projects in terms of the impact on climate action. However, DFIs continue to apply in-house, tailored metrics to mainstream climate risk assessment across the phases of project selection and evaluation. This gap represents a barrier to DFIs success at scaling up private investments into low-carbon sectors. 

In a journal article in China & World Economy, Irene Monasterolo, Jiani I. Zheng and Stefano Battison develop the first climate stress-test methodology targeted to DFIs and apply it to the overseas energy loans of two major Chinese policy banks: the China Development Bank (CDB) and the Export-Import Bank of China (CHEXIM). The tests estimate the projects’ exposure to economic and financial shocks that would result in government inability to introduce timely 2°C-aligned climate policies and from investors’ inability to adapt their business to the changing climate and policy environment. The authors find that negative shocks are mostly concentrated on coal and oil projects and vary across regions from 4.2 to 22 percent of the total loan value. Given the current leverage of Chinese policy banks, these losses could induce severe financial distress, with implications on macroeconomic and financial stability.

These results demonstrate that Chinese policy banks’ overseas energy portfolios are highly exposed to fossil fuel investments that could become stranded once technological improvements in renewable energy and late and sudden climate policies are introduced. The authors recommend that Chinese policy banks rebalance their overseas energy portfolios, moving from coal and oil to green energy sectors.