Climate Finance Impasse As Lions Asked to Turn Vegetarian

The recent speech by Reserve Bank of India Governor Sanjay Malhotra on Climate Change Risk and Finance came at a crucial moment. As efforts to protect the climate face mounting resistance, the question of who should bear the financial burden remains unresolved.

One key takeaway from the speech was Malhotra’s remark: “While the role of central banks in managing risks posed by climate change to the financial system is increasingly being recognised, their role in facilitating the financing of green and sustainable transition has been a matter of debate and has varying dimensions to it.” His mention of stress testing was also significant.

These remarks underscore the broader conflicts in climate finance: public policy and financial incentives often pull in opposite directions, consultants and multilateral agencies fuel scepticism, and stress tests fail to capture the real extent of climate risks. At the heart of the issue is a fundamental mismatch between financial stability and climate transition, leaving us asking: are banks ready to take on this responsibility?

Climate Policy Pushback
Public policy and finance should, in theory, work together to address climate change. In practice, their incentive structures often clash. While policymakers aim to mitigate long-term climate risks, financial institutions focus on short-term returns. This fundamental tension cannot be ignored, no matter how noble the intentions behind green finance initiatives.

Nothing illustrates this better than the conflicting wisdom of two American figures. John D. Rockefeller, the archetypal capitalist, once said, “The way to make money is to buy when blood is running in the streets.” In contrast, Benjamin Franklin warned, “Beware of little expenses. A small leak will sink a great ship.” The same divergence applies to climate finance—should institutions exploit economic disruptions or play the long game to prevent disaster?

This tension is fuelling broader resistance to climate-related financial policies, a backlash that could be seen as part of the wider rejection of liberalism. In Liberalism and Its Discontents, Francis Fukuyama traces this to neoliberalism or the belief that markets function best when left alone. According to Fukuyama, this faith in deregulation worked well in some areas—airline ticket prices and shipping costs fell—but failed spectacularly in others, notably the 2008 financial crisis. The question now is whether the same faith in markets can be applied to climate risk.

Sociologists Ulrich Beck and Anthony Giddens framed climate hazards as social hazards rather than natural ones, meaning that how we perceive and respond to them is shaped by social constructs and economic structures. The problem? Competing claims from various experts have eroded consensus on managing these risks. Nowhere is this more evident than in the growing scepticism toward consultants and multilateral agencies in climate finance.

Many climate finance efforts suffer from what might be called consultant capture. At a global forum focused on financial vulnerabilities, I witnessed consultants aggressively pitching their services. It was clear to the participants that these efforts were being driven by commercial interests rather than genuine risk mitigation.

Multilateral agencies, which could play a crucial role, often act similarly. In one case, a major multilateral agency took the work of one division of a public authority on stress testing and repackaged it as their own to sell to another division.

Unwieldy Stress Tests 
One of the most talked-about tools in climate finance is stress testing, which aims to assess the financial sector’s resilience to climate-related risks. The Network for Greening the Financial System has been working on this, with its first integrated assessment model boasting 800,000 variable paths, far exceeding traditional stress test models.

Yet, stress tests conducted under the European Central Bank were widely criticised for underestimating risks, despite relying on research from the Intergovernmental Panel on Climate Change. The results were shockingly benign.

Several factors contributed to this:

• The assumption of a dynamic balance sheet, meaning banks would automatically divest from climate-risky assets.
• Insufficient data provided by participating banks.
• Limited modelling capacity—most banks lacked a well-integrated climate risk stress-testing framework.
• A narrow focus on asset classes, accounting for only a third of banks’ total exposures.

Perhaps the most serious flaw was that the tests failed to account for climate’s impact on broader economic shocks.
Banks and Climate Risks

Climate risks to bank balance sheets are broadly classified into physical risks (floods, wildfires, rising sea levels) and transition risks (policy shifts, technological disruption, changing consumer behaviour). The problem is that transition risks are riddled with radical uncertainty.

The US, for instance, joined and exited the Paris Agreement repeatedly, exposing how unstable climate commitments can be. This raises key questions:

• Who should be responsible for addressing systemic climate risks—central banks, regulators, or governments?
• If banks reduce exposure to climate-risky assets, who will fill the financing gap?
• Can banks realistically finance climate-friendly but high-risk projects when their legacy industries remain their financial mainstay?

Consider ExxonMobil—its fortunes have fluctuated wildly in recent years. Legacy industries provide stable cash flows, something banks are naturally drawn to. Asking them to take on more risk without clear incentives is, as the analogy goes, asking a lion to turn vegetarian.

Road Ahead
So, what should be done? For jurisdictions with limited capacity, it may be impractical to build expensive, resource-intensive models from scratch. Instead, regulators could adapt NGFS models with local tweaks.

More importantly, stress testing should be seen not just as a technical exercise but as a tool to guide policy. European regulators have started bringing banks, industries, and experts together to figure out a gradual transition rather than simply prescribing rigid dos and don’ts.

The key takeaway is this: climate risk is a systemic problem that requires a systemic solution. Relying on fragmented, incentive-driven players—whether banks, consultants, or multilateral agencies—will not be enough.

If financial institutions are expected to drive the transition to a green economy, they need clearer incentives, consistent and durable policy, better modelling, and a coordinated regulatory approach.

Otherwise, we are simply asking the lion to turn vegetarian—without providing any alternatives for survival.