Green finance is key to sustainable growth in China, and elsewhere

China's establishment of the Asian Infrastructure Investment Bank has intensified debate about whether a new generation of development banks, led by emerging countries, is needed to ensure financing decisions account for principles of environmentally sustainable growth. Far more important, however, is whether such principles underpin developing countries' broader capital markets, which have become increasingly central to the international financial system.

The answer, as of now, seems to be yes. China and other major emerging economies appear committed to designing financial systems that support inclusive and sustainable development. But they cannot go it alone.

Policy-directed investment vehicles are critical to this effort. While the AIIB and the forthcoming New Development Bank, operated by the BRICS countries (Brazil, Russia, India, China and South Africa), are the most visible internationally, they are only the tip of the iceberg.

Sovereign wealth funds also have a significant influence on global asset markets. Likewise, monetary authorities have been playing an increasingly active role, with the major central banks' balance sheets having expanded from about US$5.5 trillion in 2005 to US$13.9 trillion earlier this year.

But such figures pale in comparison with the US$305 trillion worth of financial assets held by commercial banks, institutional investors, and other private financial institutions and individuals. How these funds are deployed will determine the shape of tomorrow's economies and the state of the environment on which they depend.

Recent reports commissioned by the UN Environment Programme neatly summarise where we are with two key data points: While global investment in renewables increased by 17 per cent last year, 116 of 140 countries registered a deterioration in their stock of natural capital. In other words, financial markets are responding to environment-related risks and opportunities far too slowly to halt potentially catastrophic damage.

This must change. Finance needs to be directed more rapidly and decisively away from natural-resource-intensive and polluting investments and towards green opportunities. Policy and market failures in the financial economy must be addressed as well.