Banking the transition to net zero: How Kazakhstan can leverage green finance to reduce emissions

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In most countries, the banking sector plays a critical role in funding the transition to a less carbon-intensive economy. Financial institutions can boost the flow of funds toward green economic activities as well as indirectly stimulate greater transparency by requiring information and public disclosures from businesses and households about green/brown investments. As countries strategize on the design of climate policy, promoting green finance through banking reform is a critical factor and tool that must be considered to really tilt the balance toward green, sustainable economic activity.

As a country highly dependent on fossil fuels, specifically "brown sectors" like coal and oil extractive industries, Kazakhstan faces significant challenges in working toward meeting its net zero carbon emission goal of carbon neutrality by 2060. And the political capital and administrative capacity for reform is limited. Kazakhstan's government will need to be selective to achieve meaningful results and must act now on building a solid foundation for green finance to achieve its climate goals.

To do so, two financial policy channels could help propel Kazakhstan's transition to net zero. One channel that can stimulate proper pricing, management, and supervision of climate-change related risks in the financial sector involves actions by the Agency for Financial Regulation and Development (AFR)-which oversees banking, insurance, pension, and capital markets. The second channel involves risk-sharing and other financial support from the government through its relevant quasi-fiscal entities to the financial and non-financial markets, most notably Baiterek Holding and its subsidiaries.

Stimulating proper pricing of climate-change related risks

Because of the extensive lending to brown sectors in Kazakhstan, the country needs to manage additional credit risk from the transition to net zero and adequately price such risk. Figure 1 indicates that regions such as Karaganda, Kostanay, and West Kazakhstan are more carbon intensive based on their leading industries (oil, gas, coal mining). But that same figure also shows these regions are among the most credited by banks. In parallel, Zhambyl and the Almaty region-with their greener industry structure-appear credit starved based on the current allocation of bank loans across regions.

Incentivizing more credit to flow to the regions with greener industries could help the transition to net zero progress faster. This could be done by banks properly reflecting the transition risks in their loan pricing. But, as Figure 2 highlights, banks largely ignore these risks in their pricing of loans based on current trends in greenhouse gas emissions of economic sectors.

Action on financial regulator enforcement

One pull-factor that can help Kazakhstan mobilize more capital to green its economy is establishing credible green policies for the financial sector and the real sector. The new Environmental Code and the introduction of an EU-based green taxonomy are crucial legal steps that will enable Kazakh economic agents to operate within a single, common framework for identifying "green" economic activities and projects. Although these steps will undoubtedly improve banks' climate risk management framework, the ability of the domestic financial system to allocate and mobilize capital efficiently-that is, avoiding "green washing" and "green bubbles," among other risks-could remain a challenge.

Kazakhstan has yet to develop a fully-fledged framework through which banks and other financial institutions can credibly earmark their financial assets as truly sustainable. In such a framework, the role of banking supervisors should not be to promote or "direct" bank credit to decarbonize the economy, but rather to ensure a sound management of climate-change related risks by banks. Kazakhstan's AFR should focus on ensuring that climate-related risks are sufficiently considered in banks' decision-making, meaning these risks are properly identified, managed, controlled, governed, and reported across all their activities. To this end, and following the example of other countries such as Georgia or Ukraine, Kazakh prudential authorities can define a strategic roadmap to complement the country's commitments to decarbonizing its economy with sound management of climate related risks in banking.

Effectively greening Baiterek Holding's operations

Baiterek is a massive financial policy tool that can do a lot of good in financial development and greening of banking activities if properly reformed. According to its 2020 annual report, Baiterek covers about 40-50 percent of credit extended to non-energy sectors in important areas of the economy where greening needs to happen such as housing, national infrastructure, and firm operations (small and medium-sized enterprises (SMEs), exporters, and agriculture). Greening the operations of Baiterek Holding can therefore generate widespread positive impacts on making the Kazakh economy more sustainable, set the strategic direction for banking and finance to go beyond ESG considerations or the application of green taxonomy, and focus capital intermediation on scaled up and verified green impacts. Baiterek can leverage the introduction of a green taxonomy to design new products that will enable the economy become less carbon-intensive and more energy efficient-such as energy-efficient housing loans, green infrastructure lending, and sustainability loans to corporates and SMEs to improve their carbon footprint.

And by applying impact investing principles, Baiterek can kick-start a virtuous cycle of orienting the operations of the financial industry on verifiable green impacts, including promoting the development of specialized companies/business lines for independent verification of green impacts. A top-down reform of Baiterek's operations can be complemented by pilot projects that reflect impact investing principles, starting with the focus on climate change mitigation, adaptation to climate change related risks, and a just transition oriented toward people. Furthermore, issuing and earmarking green loans, leasing, equity investments, and insurance support can help Baiterek start raising green bonds through both the KASE and AIX stock exchanges, decisively contributing to the development of a green capital market in Kazakhstan and in Central Asia.

The World Bank has engaged with Kazakhstan's financial regulator to help advance the regulatory response to climate change in Kazakhstan and with the Ministry of National Economy on Baiterek's reform to promote financing of green projects more effectively.

By focusing on these areas of reforms to the banking sector, Kazakhstan could set the foundations for green finance that would serve its carbon emission goals-helping to ensure a more sustainable and inclusive future for all Kazakhstanis.