Cost of Capital, Concessional Finance and Adaptation Investment

Adaptation investments are crucial to build economic resilience to climate risks and maintain economic competitiveness. However, the high cost of capital is a barrier to increased investment, especially in emerging markets and developing economies. The role of National development banks’ (NDBs) concessional lending to ease access to adaptation finance has been advocated but we know little about the conditions under which it can effectively catalyze adaptation investments, and its macro-financial implications. Here we quantitatively study the impact of NDBs’ concessional finance on the cost of capital for adaptation investments, on future economic damage reduction, and on economic recovery. We model climate resilient capital and a national development bank in a Stock-flow Consistent macro-financial model, which integrates forward-looking disasters risks from the Network for Greening the Financial System short-term climate scenarios. We calibrate the model to Brazil and the Brazilian Development Bank (BNDES). We find that concessional lending can crowd-in private investments in resilience, and increase the share of resilient capital in the economy to up to 20% over 10 years, easing firms’ access to banks’ co-financing in the aftermath of the natural disasters. Furthermore, BDNES’ derisking of adaptation investments contributes to increase Brazilian banks’ financial stability: higher firm resilience to climate risks dampens the increase in default probabilities and credit risk following natural disasters. At the same time, our results show a balance-sheet trade-off in the design of concessional lending depending on the level of concessionality. Thus, scaling up adaptation through NDBs may require complementary fiscal and financial measures.