The Financial System We Need: Aligning the Financial System with Sustainable Development

Farmers’ ability to access reliable and inclusive systems of finance is critical for agricultural growth and economic development. Proper financing enables farmers to make long-term productive investments and to overcome short-term crises. In 2008, the world experienced the worst global financial crisis in decades (information on the relationship between food prices and financial activity, as well as agriculture and financial policies can be found in these recent blog posts from IFPRI and the Food Security Portal ). In the wake of this global financial crisis, recognition has grown that the global financial system must become resilient, inclusive, and sustainable.

The United Nations Environment Programme’s Inquiry into the Design of a Sustainable Financial System was established to support this transition in the global financial system. UNEP recently released a report covering the Inquiry’s findings, conclusions, and recommendations at both the national and the international level.

The current financial system is a result of many historical choices; in addition, the world’s economies, societies, and environment are all closely interlinked. In this context, the current global financial system as a whole will need to change in order to finance sustainable development. Capital flows will need to be redirected toward critical priorities, such as increasing agricultural and ecosystem resilience, and away from assets that deplete natural capital. The Sustainable Development Goals (SDGs) establish some of these critical priorities for sustainable development; for example SDG 2 aims to end hunger, achieve food security and improved nutrition, and promote sustainable agriculture (an IFPRI blog on a new food system for achieving the SDG’s can be found here ). The FAO estimates that eliminating hunger by 2025 will require an additional US$43.9 billion per year of investment in: rural infrastructure and market access (US$18.5 billion), development and conservation of natural resources (US$9.4 billion), public R&D and extension (US$6.3 billion), rural institutions (US$5.6 billion), and rural electrification (US$4.1 billion).

The report argues that the world is currently faced with a historic opportunity to shape a financial system that supports sustainable development. This opportunity is based on a growing trend in policy innovation from central banks, financial regulators, and standard setters, who are incorporating sustainability factors into the rules that govern the financial system. More specifically, the Inquiry found over 100 examples of policy measures aimed at sustainable development across 40 countries; these policies target major asset pools and financial actors, as well as the underlying governance of the financial system.

Developing and emerging economies are leading this revolution, driven by a focus on economic transformation, social inclusion, and local environmental priorities. For instance, one of India’s core financial policies is the Priority Sector Lending (PSL) requirement; this requires banks to allocate 40 percent of lending to key sectors such as agriculture and small and medium-sized enterprises. In April 2015, the Reserve Bank of India included lending to small renewable energy projects within the PSL targets. By doing so, India is financially supporting the development of the sector upon which most of its citizens are directly dependant (i.e., agriculture), as well supporting the creation of renewable energy sources.

The report places significant emphasis on the importance of inclusivity in the global financial system. Currently, billions of people and millions of small businesses lack access to financial services. Increasing financial access is especially important for the rural and agricultural sectors, as most of the people who lack access to financial services live in rural areas. In this regard, the report highlights Bangladesh’s experience. The Central Bank of Bangladesh is making efforts to allow more inclusivity, deploying its financial and regulatory capacities to advance financial services to many disadvantaged individuals, as well as offering low cost refinancing to commercial banks that lend to the rural economy.

Aligning the financial system with sustainable development will require a systematic approach and a clear framework that goes beyond “business as usual.” The Inquiry’s Framework for Action provides such a systematic approach, drawing on a toolbox of measures based on countries’ experiences. The framework proposes policy packages for assets and actors and a set of tools for developing a unified financial framework. Simple measures to improve market practice, such as enhanced disclosures, may be useful starting points but will not deliver a significantly improved system by themselves. Additional measures such as priority lending to the poor and strengthened environmental liability, on the other hand, may drive greater change over time.

Regarding next steps, the report highlights that building upon the current global momentum toward sustainable development will require both national leadership and international cooperation. At the national level, a high-level diagnosis of countries’ needs and opportunities within the current financial system is needed, as is the development of a broad-based social compact involving public agencies, financial institutions, and civil society. Internationally, the report highlights ten broad areas where increased cooperation is necessary: four of these focus on specific asset pools and actors (for instance, on developing a green capital market). Broadly, these recommendations highlight the need for a global system that places economic value on resources and ecosystem services and linking these to financial actors. For instance, placing an increased economic value on resilient (or non-degraded) agricultural land and/or its capacity to contribute to carbon sequestration would provide global financial incentives to the preservation and development of resilient fertile agricultural land.

Five recommendations focus on developing the governing architecture of a financial system geared towards sustainable development. Broadly, these recommendations focus on the development of global standards and indicators related to sustainability. For instance, increased global disclosure on financial flows will allow the development of more socially-focused financial standards that ensure that rural areas as well as urban areas have access to and benefit from financial services. Lastly, the report recommends the establishment of an international research consortium combining the expertise from a wide array of actors to research under-explored topics and themes. The report highlights that this research needs to go beyond the design of specific tools (such as sustainability stress tests) or statistics (performance framework) to encompass the multi-disciplinary and multi-dimensional nature of a sustainable financial system.