Catalysts for change: Can green bonds accelerate Europe's transition to a green economy?

Nearly two decades of green bond issues have ignited various research questions and fields surrounding the topic. It is therefore time to take stock. Green bonds were launched with the goal of greening the financial sector by investing the generated funds into sustainable projects that support the transition to a resilient, climate-neutral economy. But are green bonds living up to their promise? In this policy brief, we provide evidence on the role that green bonds can play in the green transition. Our findings are based on a recent project funded by the German Federal Ministry of Research, Technology and Space (BMFTR). When examining the potential distortionary effects of policy interventions (such as green government bond issues) in the green bond market, we only find small effects on average, even though those are stronger for large and specific interventions. Looking at green bond auction design from a theoretical perspective, it can be seen that strategic bidding behaviour can incentivise investors to shift their portfolios towards green investments in general. When banks issue green bonds, they increase the financing of green firms in the form of sustainability-linked loans. As a result, environmental benefits materialise as recipient firms reduce their emissions. These effects are only evident for firms that are already greener than others, however, so more targeted incentives seem needed to channel financial flows more effectively into sustainable transition projects.