THE 27th Conference of Parties to the United Nations Framework Convention on Climate Change, or COP 27, took place in Sharm El Sheikh, Egypt, last month. Against the backdrop of the catastrophic floods which affected 33 million people and resulted in estimated economic losses of $40 billion to Pakistan, Minister for Climate Change Sherry Rehman made a strong case for the establishment of a ‘loss and damage finance facility’ that would help vulnerable countries adapt to and mitigate the impact of climate change.

Nine years ago, UN climate negotiators had agreed to a formal mechanism to combat loss and damage, but no progress was made on this front as wealthy nations were unwilling to be held responsible for their historically high contributions to global emissions. Ahmad Rafay Alam, a Pakistani environmental lawyer and activist, has pointed out that the fire that damaged the Notre Dame cathedral in 2019 resulted in an influx of donations amounting to $877m in two days. However, of the $816m to be raised by the UN to help Pakistan deal with the aftermath of the catastrophic floods, just $90m had been received.

Capital markets provide a unique opportunity to raise climate funding. Coupled with the presence of Islamic financial institutions in critical emerging markets of the Global South, capital markets could help restructure financing from developed to developing nations. Islamic finance tools such as sukuk (a Sharia-compliant bond) and takaful (an Islamic alternative to insurance) have the potential to bridge the climate funding gap. The faith-based principles of Islamic finance are aligned with the Sustainable Development Goals and support the protection of the environment, fair distribution of wealth, equal opportunities and the avoidance of harm. Islamic finance can reinforce its position as an ethical and feasible financing option by expanding its role in green finance.

The fundamental focus of Islamic finance on social impact, especially through Islamic social finance institutions (eg zakat (faith-based charity), auqaf (charitable endowments)), and increased awareness of risks associated with climate change and climate disasters, provide another solid basis for supporting the green, inclusive and resilient recovery agenda of countries impacted by climate change. Zakat funds can be used to address humanitarian needs arising from the impact of climate-induced natural disasters if the beneficiaries meet specified criteria, while auqaf may directly engage with the provision of goods and services related to climate mitigation and adaptation and can also be dedicated to climate research and development. Islamic microfinance institutions can fill a vital gap that has not been met by conventional microfinance institutions by targeting the rural poor, the majority of whom are underbanked.

There is an opportunity for local financial institutions to scale up the adoption of Islamic financing for green projects.

Pakistan, it has been observed “has the second-largest Muslim population in the world with very low banking penetration”. According to the Financial Inclusion Insights survey 2020, financial inclusion in Pakistan is around 21 per cent, the lowest in South Asia. The government wants to boost financial inclusion by promoting Islamic finance as a part of its National Financial Inclusion Strategy.

According to ratings company analysis, “Islamic banks are the largest contributor to the Islamic finance industry at 67pc (total assets), followed by sukuk at 26pc (outstanding amount), Islamic funds at 6pc (total assets) and takaful at 1pc (total contributions)”. Despite the pandemic-driven economic slowdown, Islamic financing expanded at an average compound rate of 10.5pc in 2020 and 2021, while conventional loans extended by only 3.4pc during the same period.

The recognition of climate change as a material risk for the banking sector has increased significantly. A survey of the Islamic DeveIopment Bank’s 57 member countries showed that 97pc of IDB’s clients believe that climate adaptation is an important consideration in investment decisions. Climate adaptation projects across all sectors constituted 35pc of the total commitment at the bank in 2021. Further, an average of 55pc of IDB’s total commitments to climate action over the past five years have been dedicated to climate adaptation and this figure is predicted to grow in the future.

Since COP27 was held in Egypt this year and COP 28 next year will be held in the UAE, both Muslim-majority countries, this platform can be leveraged to promote Sharia-compliant financing for climate adaptation and impact mitigation projects in vulnerable countries.

Developing Asia is home to 62pc of the global Muslim population, with 45pc residing in Indonesia, Pakistan, India and Bangladesh alone. Islamic finance is in high demand in these countries and with high growth potential. The Asian Development Bank’s recent report on Unlocking Islamic Climate Finance describes “how greening Islamic capital markets and social finance, mobilising project finance for infrastructure and boosting financial inclusion, can play a key role in funding the climate agenda”. For example, green Sukuk issuances in the real estate and transport industries can support the development of sustainable, environment-friendly green buildings and the electrification of public transport. Climate mitigation projects in the transport, energy, agriculture, water and sanitation sectors are also suitably structured for asset-financing through Islamic finance instruments.

The State Bank of Pakistan’s Environmental & Social Risk Management Manual provides tools and guidelines to assess and manage environmental and social risks in the banking sector in an effort to promote sustainable banking in Pakistan. There is an opportunity for local financial institutions to scale up the adoption of Islamic financing for green projects. Due to the high asset-intensity of Islamic finance, and concentration in specific sectors such as real estate and construction, promoting Islamic climate finance will require a focused effort from industry players to develop relevant products and financing modalities. Accordingly, there is a need to invest heavily in strategic research, support programmes to help the main industry players to transition to climate finance, and support the development of relevant products such as climate takaful or green auqaf or zakat programmes.

Maha Qasim is an environmental and sustainability expert. Noor Fatima Anwar is a research analyst.

Published in Dawn, December 8th, 2022