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(Bloomberg) — Wall Street’s biggest banks are warning that existing assumptions around much-needed green finance will no longer hold if the US goes ahead with stricter capital requirements.

The Basel 3 Endgame, as the planned rules have been dubbed, marks the final implementation stage in the US of regulations created after the financial crisis of 2008. Banks will need to set aside more capital, which will make it costlier for them to provide finance. Proposed in July by a group of US authorities that includes the Federal Reserve, the rules will “fundamentally alter” how banks in the world’s biggest economy approach risk, EY says. 

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JPMorgan Chase & Co. estimates the plan would leave it facing a 25% capital bump, which would “for sure” affect its ability to allocate funds to green projects, according to Chief Operating Officer Daniel Pinto. And Goldman Sachs Group Inc. Chief Executive Officer David Solomon says the bank’s capital requirements would “quadruple” for certain clean energy projects.

The upshot is that Wall Street will have to rethink existing climate financing structures, said John Greenwood, co-head of Americas structured finance at Goldman.

“Given all the things that commercial banks are facing in the context of Basel,” the financial structures of existing climate deals are starting to look a bit “antiquated,” Greenwood said in an interview. That’s particularly true of a climate-funding model known as blended finance, whereby deals are de-risked by the public sector in order to lure private capital. Those enticements are now going to need to take banks’ extra capital costs into account, he said.

The eight biggest US banks currently have capital requirements ranging from $9 to $13 for every $100 in risk-weighted assets. Under the new rules, they would need to add roughly $2 more. 

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“With the incremental capital needed to fund the green transition, banks will look to work alongside other corners of private finance that perhaps aren’t subject to the same regulations,” Greenwood said. “What we’re seeing now in terms of new investment in energy and infrastructure is really a need for how do we crowd in and support institutional investors, given the constraints that commercial banks have under Basel.”

It’s the latest reality check from a finance industry that spent much of the COP28 climate summit in Dubai reminding the world that it will only participate in the green transition if the returns are appealing. “You have to make a profit,” hedge fund billionaire Ray Dalio said at COP28. And private capital can’t get involved if there isn’t “a commercial return,” Shriti Vadera, chair of Prudential Plc, said in Dubai.

Read More: Hedge Fund Titan Ray Dalio Gets Profits Back on Green Agenda

According to Jeff Berman, New York-based partner and US financial services regulatory group lead at law firm Clifford Chance, Wall Street is now “looking at a trade-off between the safety and soundness of the banking system, and the goals of climate policy.”

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The clear message from bankers is that achieving a commercial return will be harder once capital requirements go up. That means a lot of finance is set to move away from banks and into the murkier realm of shadow banking, where risk levels aren’t monitored as closely, according to the industry.

“Policymakers should be concerned with a resulting shift away from regulated entities to less-regulated and less transparent markets and institutions,” JPMorgan CEO Jamie Dimon said in a Senate hearing earlier this month. 

Goldman’s Solomon says financing will happen in corners of the market over which “regulators have far less visibility,” meaning risks could build up and “ultimately lead to financial shocks.”

Read More: Why Bigger ‘Capital Cushions’ Have Banks On Edge: QuickTake

Multilateral development banks agree that green finance models may need to be adjusted because of the regulatory environment.

Odile Renaud-Basso, president of the European Bank for Reconstruction and Development, said Basel 3 presents “a good excuse” for global banks to back away from climate finance. “But there are maybe some elements that we need to look into because emerging market risk is seen as variable and the approach isn’t very conducive for placement,” she said.

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Wall Street has spent the past months warning of the impact of stricter capital rules on everything from mortgages to small business loans. The United Nations climate summit was just the latest venue for bankers to spread their message.

In a research paper distributed at COP28, Citigroup Inc. said regulators should “consider the implications of structures such as Basel 3, which can inadvertently hinder investment into infrastructure projects and markets that could make a meaningful difference to climate and development finance.” 

The Basel 3 rules make financing green infrastructure difficult for banks, Jay Collins, Citigroup’s vice chairman of corporate and investment banking, said in an interview. That’s because it’s typically funded at the project level and tends to be long-term and illiquid, which is the kind of lending the Basel rules deter.

“As long as there is so much policy noise and regulatory fog, the multifold increase in climate investment won’t happen,” Collins said.

Read More: Citi Explores New Deal Structures in Battered Offsets Market

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Hendrik du Toit, CEO of South Africa-based asset manager Ninety One, said his concern is that American and European financiers are already too risk-averse, and any additional hindrance will end up hitting the emerging markets most in need of climate finance.

“Western capital is too conservative,” he said during a panel discussion in Dubai. “It’s buying dollar cash, US dollar bonds, and it’s comfortable sitting at home. We have to change that. There are returns to be had” in emerging markets

The risks associated with climate finance were underscored this year, as higher interest rates and supply-chain bottlenecks dragged down key green sectors. The S&P Global Clean Energy Index is down almost 30% in 2023, compared with a 23% gain for the S&P 500.

Citigroup’s Collins said the numbers speak for themselves. The Basel rules mean “global banks will continue to struggle to meet regulatory capital return hurdles on green infrastructure,” he said.

—With assistance from Alastair Marsh.

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