Green investment needs in the EU and their funding

Prepared by Malin Andersson, Petra Köhler-Ulbrich and Carolin Nerlich^[1]

Published as part of the ECB Economic Bulletin, Issue 1/2025.

1 Introduction

The green transition towards a climate-neutral economy is a key challenge for the EU and requires substantial investment to 2030 and beyond. Climate-related disasters are increasing in frequency and severity in Europe and elsewhere, pointing to substantial investment needs to speedily decarbonise the economy and adapt the EU to a changing climate. Estimates of the additional amount that should be invested in capital expenditure and low carbon-emitting durable consumption goods each year until the end of this decade range from 2.7% to 3.7% of 2023 EU GDP. A delay in the decarbonisation, in particular at the global level, would push up transition and adaptation costs even further. At the same time, an investment-led transition towards a low-carbon economy will entail a wide-ranging structural shift, which is expected to affect growth and prices as well as the financial sector. For all these reasons, the ECB is carefully monitoring developments, as outlined in this article.^[2]

Substantial amounts of funds will be required for the green transition. To achieve the above aims, the contribution of the private sector to funding green investment will be key, also given current public finance constraints. While bank financing is expected to make a vital contribution to the green transition, capital markets in Europe will need to expand and integrate more fully to better support green innovation and start-ups. The public sector can play an important role in fostering private investment in the green transition by reducing the financing costs of borrowers and de-risking green investment activities, albeit within the bounds of the available fiscal space.

A combination of structural reforms and good business conditions is crucial to underpin the green transition. Obstacles to the green transition include the limited availability of skilled staff in the field of clean and sustainable technologies, the challenges of setting up green businesses and uncertainty about future climate strategies. Public policies should aim to remove structural rigidities, improve regulatory and administrative efficiency and foster green innovation. Structural reforms can incentivise firms, households and investors to step up green investment activities.

Against this background, this article assesses the green investment needs in the EU and the ways that these can be financed. In Section 2, a range of estimates of green investment needs prepared by several institutions is assessed. Section 3 contains a discussion on the role of the private sector, especially banks, in financing the green transition, as well as the role of the public sector in supporting green investment. Section 4 reviews the main obstacles to the green transition and policy options to address them. Section 5 concludes.^[3]

2 Estimates of green investment needs

Substantial investment is needed in the EU in the coming decades to enable the green transition, reduce greenhouse gas (GHG) emissions by 55% from 1990 levels by 2030 and reach net-zero emissions by 2050. Analysis by the European Commission shows that, in the period from 2011 to 2020, an average of €764 billion was invested in the EU each year to reduce GHG emissions (Chart 1, panel a). This is about 5.1% of the EU’s GDP in 2023. To reach the 2030 target, the Commission estimates that an additional €477 billion of green investment will be needed each year, equivalent to 3.2% of 2023 GDP.^[4] In sum, total green investment of around €1.2 trillion each year, equivalent to 8.3% of 2023 GDP, is needed. The definition of green investment used here is broader than that used under gross fixed capital formation in national accounts, as it includes low carbon-emitting durable consumption goods such as electric vehicles. It is important to stress that a substantial part of this investment, as further discussed below, is not additional but rather substitution for investment goods and purchases of durable goods which are not considered “green”. For example, purchases of electric cars will substitute acquisitions of fuel combustion engine cars. The same applies to the installation of new domestic heating systems.

Chart 1

Estimates of total annual green investment needs in the EU

a) Estimates of total green investment needs

(EUR billions, annual by 2030)

b) European Commission estimates by category

(EUR billions, annual by 2030)

Estimates of green investment needs differ across institutions, both for total investment and the additional amounts needed. Compared with those of the European Commission, the figures for total green investment needs presented by other institutions are considerably smaller, mostly due to lower historical estimates (Chart 1, panel a). Focusing on the estimates of additional green investment needs − the amounts needed each year on top of continued investment of past amounts – these range between €558 billion according to BloombergNEF (BNEF) and around €400 billion according to the International Energy Agency (IEA) and the Institute for Climate Economics (I4CE) until 2030. This implies that additional amounts of green investment between 2.7% and 3.7% of 2023 EU GDP will be needed each year until the end of this decade. As assessments of green investment needs involve a high degree of uncertainty, most studies rely on a variety of scenarios.^[5]

The variations can be attributed mainly to differences in the coverage and definition of the sectors as well as the underlying methodologies. The estimates vary depending on whether the full costs of green investments are considered or only the additional costs compared with legacy technologies. For example, the estimates for the transport sector by the European Commission and I4CE include the full production cost of electric vehicles, while the IEA only considers the battery costs. Moreover, estimates depend on the coverage and definition of the sectors included. BNEF and the IEA, for instance, include investments in hydrogen, nuclear and carbon capture, while only BNEF includes green investment in shipping. Furthermore, the estimated investment needed to increase the energy efficiency of buildings varies widely across institutions, and some institutions do not capture the building sector in their estimates.

Zooming in on the sectoral estimates, investment needs vary significantly across sectors. According to the European Commission, in absolute terms most investment is needed in the transport sector, with a total of €754 billion per year required for its transition towards carbon neutrality (Chart 1, panel b). By far the largest share, amounting to around 80%, relates to investment in road transport, which includes passenger transport and the charging infrastructure for electric vehicles but also goods transport. In relative terms, by contrast, the largest increase in green investment will be needed in clean energy supply. Compared with historical averages, investment in this sector will need to increase by a factor of around 1.7 annually until 2030 to decarbonise energy supply.

The estimates for additional green investment needs can be seen as a lower bound in view of investment shortfalls and the only selective coverage of sectors. Despite recent progress, Europe’s green investment activities have so far fallen short of what would have been needed annually until 2030 to achieve the decarbonisation target. Slippages were particularly noticeable during the pandemic. To compensate for the considerable shortfall compared with the target levels, more investment will be required in the remaining years to 2030.^[6] If this is not achieved, a delay in the green transition would imply additional costs for adaptation.^[7] Possible reasons for the shortfalls are poor access to, or high costs of, finance and a policy framework that fails to support, or even hinders, the green transition, as discussed below. Another reason why the estimates of annual investment may be understating the actual needs relates to the sectoral coverage. As mentioned above, some estimates do not include the full spectrum of sectors that will be impacted by the green transition. Taken together, this all means that the estimates outlined here should be considered a lower bound.

3 The funding landscape for green investment

The green transition requires substantial funding, in particular by the private sector but with support from the public sector. This section looks at both of these sources of finance.

The role of banks and financial markets

Banks are expected to play a crucial role in financing the green transition in the euro area. The green transition requires substantial amounts of funding, largely expected to be provided by the private sector. Given that loans from euro area banks account for nearly 60% of the stock of debt finance of euro area non-financial corporations and for more than 80% of the stock of debt of euro area households, banks make a key contribution to the financing of those activities that result in the release of carbon emissions.^[8] Banks are therefore expected to play an important role in the financing of the green transition. The amount of carbon emitted by corporates in the euro area that can be linked to funding from euro area banks trended down overall from 2018 to 2021, but banks continued to be highly exposed to firms’ carbon emissions (Chart 2).^[9] This exposure varies widely across industries, but is particularly large in the manufacturing, energy and transport sectors, which underscores the challenges these sectors still have ahead of them in the green transition.

Chart 2

Industry sector breakdown of firms’ carbon emissions that can be linked to funding from euro area banks

(million tonnes of scope 1 emissions, single-entity level)

Banks consider climate risks in their lending conditions, in terms of both transition and physical risks. In a specific climate-related question in the July 2024 euro area bank lending survey (BLS), banks reported that they grant a climate-related discount to firms with low carbon emissions and firms demonstrating considerable progress in their green transition (Chart 3, panel a). By contrast, high-emitting firms which may have so far postponed producing a credible green transition plan or have made little progress in that regard are charged a climate risk premium in their lending conditions. Banks may also reject a loan application if they have doubts regarding the sustainability of a firm’s business model or perceive a higher risk of corporate default in the medium term.^[10] This demonstrates that banks recognise firms’ transition risk as a relevant credit risk leading to tighter credit conditions (Chart 3, panel b). In addition, the financing of investment in innovative green technologies typically entails higher credit risk, making their funding more costly. Banks also assess a firm’s physical risk, often linked to its geographic location, as a relevant risk in their climate-related credit assessment, as this can affect the value of collateral and the firm’s value more generally (blue bars in Chart 3, panel b). They expect the relevance of these climate-related risks to increase over time (yellow bars).

Chart 3

Changes in banks’ credit standards for firms and impact of climate change on bank lending conditions and loan demand

a) Changes in banks’ credit standards for firms and impact of climate change

(net percentages of banks)

b) Selected climate-related factors with an impact on lending conditions and loan demand

(net percentages of banks)

Climate-related fiscal support improves the likelihood of a loan being approved and mitigates the financing costs for firms, facilitating investment in the green transition. According to banks participating in the BLS, climate-related fiscal support, in the form of state guarantees or subsidies for example, can help to reduce banks’ exposure to climate risks, thereby easing credit conditions and helping to boost loan demand (Chart 3, panel b). However, banks indicated in the July 2024 BLS that the actual beneficial impact of climate-related fiscal support on bank lending conditions over the previous 12 months (blue bars) was substantially lower than they had expected a year earlier (yellow bars). The positive impact that fiscal support can have on firms’ green investment decisions is also confirmed by the firms themselves, especially small and medium-sized enterprises (SMEs). Meanwhile, large firms point in particular to the important role played by retained earnings as a source of funding for planned green investment, while capital markets still play a smaller role (Chart 4).^[11]

Chart 4

Firms’ plans to finance green investment

(percentages of firms)

Financial markets can help to speed up the green transition, also by providing funding for riskier projects and green innovation, although these market segments are still small. Market-based financing involving the issuance of sustainable debt securities still plays only a limited role in the euro area, accounting for around 7% of the stock of all debt securities issued, with green bonds constituting the largest market segment (Chart 5).^[12] While the market share of sustainable debt securities has grown rapidly over recent years, growth has slowed somewhat of late, especially for sustainability-linked bonds. Other market-based sources of funding, like private equity, play only a minor role in the EU.^[13]

Chart 5

Market-based financing sources by segment

(left-hand scale: EUR billions, outstanding amounts at face value; right-hand scale: percentage share of total euro area debt securities issuance)

The role of public funding

Private funding needs to be supported by public sector action. Support from the public sector can come either directly in the form of public investment or indirectly in the form of subsidies or state guarantees. It can incentivise private green investment by reducing borrowers’ financing costs and de-risking green investment activities for firms and potential creditors alike. Helping the private sector to invest in the green transition can be particularly beneficial due to the high level of uncertainty surrounding the rate of return when financing innovation and new technologies. At the same, fiscal space for extensive public sector support is constrained by the requirement to preserve fiscal sustainability in Europe.

At the EU level, public funds are supporting the green transition, with the largest contribution coming from the Recovery and Resilience Facility (RRF). For the current EU budgetary period 2021-27, there is a requirement for at least 30% of the combined funds from the multiannual financial framework (MFF) and the Next Generation EU (NGEU) programme to contribute to climate objectives.^[14] The RRF, which is the centrepiece of the NGEU programme, provides the largest share (€276 billion) of the total funds made available by the European Commission to support climate objectives (€658 billion; Chart 6, panel a).^[15] Further public funds are provided by the European Investment Bank (EIB), by auction revenues from the EU Emissions Trading System (EU ETS) and by national policy initiatives.

The single largest share of the climate-related RRF funds goes to firms, but so far the absorption rate of these funds has been low (Chart 6, panel b). The support measures offered to firms, amounting to 43% of the climate-related RRF funds, come mostly in the form of subsidies and tax credits which aim to promote green investments in areas such as energy infrastructure, company electric vehicles and greater building energy efficiency. So far, however, the absorption rate of these funds has generally been low.^[16] By mid-2024 only 20% (around €55 billion) of the climate-related RRF funds had been disbursed, with the remainder still available to be spent until the end of 2026. The low absorption rate may be partly related to bottlenecks caused by insufficient administrative capacity and complex governance structures. The performance-based nature of the RRF means that financial support is not provided until pre-defined milestones and targets have been met. By contrast, as much as 40% (around €150 billion) of the climate-related funds committed under the current MFF had been disbursed by the end of 2023.

The available EU funds can largely cover the public green investment needs up to 2026, although a green public funding gap may open up when the RRF expires. No benchmark has been established yet to determine the optimal role of the public sector in mitigating climate change. That said, a broad estimate of the public share of the additional investment needs may be derived from the weighted public investment share of each sector.^[17] This stylised exercise results in an overall public sector share of around 17% of the additional climate-related investment needs over the period from 2021 to 2030, which is equivalent to around €83 billion per year.^[18] Compared with the available EU funds and under the assumption of full disbursement of the RRF funds by the end of 2026, the green public funding gap would be limited to an average of €20 billion per year (around 24% of the public funding needs) between 2025 and 2030. This result is sensitive to the underlying assumptions, however, especially the full use of the RRF envelope. The green public funding gap is likely to become substantially larger after the RRF expires at the end of 2026 (green bars in Chart 6, panel b). Yet, limited EU public funds after 2026 may reduce the ability of the public sector to crowd in private investment.^[19]

Chart 6

EU public funds for the green transition and the green public funding gap

a) MFF and NGEU envelopes contributing to climate objectives, by programme

(shares of total envelope devoted to climate objectives)

b) Annual green public funding gap over time

(EUR billions, 2021-30)

4 Policy options to support green investment

Structural reforms will also play an important role in supporting the transition to a climate-neutral economy. The green transition requires an institutional framework and structural reforms that facilitate the reallocation of resources from high-carbon to low-carbon activities, incentivise green innovation and new business models, and provide a favourable environment for the deployment and diffusion of low-carbon technologies.

However, a recent survey by the European Patent Office (EPO) and the EIB revealed major structural barriers to green investment, with for instance the availability of finance being more problematic here than for investing firms in general.^[20] Around 30% of cleantech firms stated that issues with the availability of finance acted as a major obstacle to investment.^[21] This is twice the share reported by the broader range of non-financial firms surveyed in the wider EIB Investment Survey (Chart 7).^[22] Skill shortages and regulatory barriers including complex and diverse regulations across the EU are major challenges for firms. Other bottlenecks include difficulties in finding demand for new products and services, as well as the high cost and complexity of finding and negotiating with business partners. Policies to improve the quality of education, upskilling and reskilling of the labour force as well as to spur labour mobility to green sectors are key to support green investment.^[23]

Chart 7

Obstacles to business activities related to clean and sustainable technologies in the EU

(percentages of firms)

The recently published report authored by Mario Draghi highlights the key role that simplifying and harmonising regulations at national and EU levels can play in supporting innovation and the scaling-up of EU firms.^[24] This could be achieved by creating a European Innovative Company (EIC) label, for instance, under which EU companies would be able to operate under a limited and harmonised set of legal obligations covering corporate law, insolvency procedures and some key aspects of labour and tax law.^[25]

Carbon taxation, which is widely seen as the most efficient policy instrument to incentivise private investment in the green transition, is expected to increase.^[26] In Europe, the EU Emissions Trading System (EU ETS) works indirectly as a carbon tax, with the carbon price being determined by auctions of emission permits. A new EU ETS2 will be introduced in 2027 to cover emissions from building heating and transport.^[27] In addition, several EU Member States have explicit carbon taxes in place, though often with a limited tax base and rate. The effective carbon rate, which combines EU ETS prices, actual carbon taxes and fuel excise taxes, is still well below the effective carbon rate that would be needed to achieve the 2030 emission reduction target in the absence of other measures.^[28]

Finally, it is vital to advance the capital markets union agenda, also for the green transition. More sophisticated venture capital markets would make it easier for innovative EU firms to access risk capital and to grow. In addition, well-designed savings products would help to channel European savings towards longer-term, higher-return investments.^[29] In particular, patents are important to attract venture capital and serve as debt collateral.^[30] Capital market imperfections such as asymmetric information may discourage investors from channelling funds towards green research and development. Patents can mitigate such financing constraints by sending important signals when the prospects of young companies are being assessed.^[31] To improve its role in cleantech innovation, it is essential for Europe to reap the full benefits of the Single Market and tackle regulatory fragmentation.

5 Conclusions

In this article we look at the green investment needs in the EU to 2030, how they are funded and policy options that would support the green transition. A key message is that the green investment needed in the EU in addition to what has already been spent is substantial, up to 3.7% of 2023 GDP annually. Moreover, banks – which play a key role in the financing of the euro area economy – have started to reflect climate risks in their lending. By contrast, green financing via financial markets − ranging from green bonds to venture capital − is growing but is still at a low level. The public sector can play an important role in crowding in private investment and mobilising more private funding for green investment. A significant green public funding gap is, however, expected to emerge as of 2027 following the expiry of the RRF. Furthermore, structural policies are essential to support green investment and innovation in green technologies, while a shortage of green skills and a high regulatory burden are seen as obstacles. Finally, it will be a challenge to fund the massive green investment needs, in part due to shortfalls that have already taken place and the expected green public funding gap after the RRF expires. Further progress towards more integrated European capital markets appears crucial to mobilise private funding sources beyond bank lending.

Looking beyond the 2030 green transition horizon, available estimates point to even higher investment needs to reach the goal of carbon neutrality.^[32] While associated with even greater uncertainty than the estimates presented here, estimates of investment needs beyond this decade suggest a need to further accelerate green investment activities at both the national and the EU level. Moreover, adaptation investment may turn out to be sizeable, in particular if the effects of climate change become more pervasive.