Sustainable finance and the circular economy: Opportunities for financial institutions

The circular economy replaces the traditional “take-make-waste” economic model with a regenerative system focused on the principles of eliminating waste, keeping resources in use, and restoring natural systems. It is a critical enabler for building a sustainable future aligned with climate, biodiversity, and pollution goals.

However, global progress on the circular economy is lagging. According to the Circularity Gap Report 2024, the global circularity rate has dropped from 9 percent in 2018 to just 7 percent in 2023. (The global circularity rate measures the share of materials consumed worldwide that are derived from recovered and reprocessed materials rather than virgin materials.) This decline is driven by increasing consumption and reliance on virgin materials, trends exacerbated by the resource-intensive transition to a decarbonized economy. For instance, renewable energy infrastructure, battery production, and electrification processes require significant inputs of raw materials.

The role of FIs

Financial institutions (FIs) are pivotal in financing the transition to a circular economy. By integrating circular principles into their climate strategies, FIs can help reshape high-impact industries and drive innovation in sustainable practices. This shift not only supports environmental goals but also enables FIs to reduce portfolio risks, align with evolving regulations, and respond to increasing stakeholder expectations.

How regulation and existing commitments support circularity

FIs’ current climate commitments, such as aligning with frameworks like the Paris Agreement and the EU Taxonomy, already implicitly support the transition to a circular economy by promoting decarbonization and sustainable resource use. However, FIs often struggle to explicitly make this connection in their strategies and relationships. By integrating circular economy principles into their risk management and investment strategies, FIs can gain access to the opportunities while encouraging necessary change.

FIs and circular economy practices

A review of the environmental and social (E&S) risk policies and climate reports of major FIs show how these institutions are engaging with circularity within specific sectors and across value chains.

Sector-specific approach

FIs using a sector-specific approach target high-impact industries such as chemicals, plastics, real estate, and textiles. For instance:

• In real estate, FIs promote the use of sustainable materials such as recycled cement and aluminum as part of their expectations for clients operating in the sector.
• In chemicals, FIs focus on reducing waste and transitioning to cleaner production processes. However, risk management considerations often lack depth, and only a minority of FIs require clients to adopt circular practices as part of financing requirements.

Figure 1. shows that most of the FIs reviewed do not apply circularity considerations to specific sectors in their E&S risk policies. Among the FIs that do take a sector-specific approach, the chemicals industry was the most common target, followed by the packaging and food and beverage sectors.

Figure 1.Proportion of FIs monitored by ECOFACT that address the circularity potential of specific sectors in their E&S risk policies and climate reports

Value chain integration

Many FIs consider circularity across all stages of the value chain—upstream, midstream, and downstream. FIs that consider circularity prioritize investments by supporting companies that focus on the following activities:

• Upstream: Modular product design and reducing virgin material use, particularly in electronics.
• Midstream: Sustainable manufacturing processes and lifecycle management in automotive and information and communications technology (ICT) sectors.
• Downstream: Recyclability and waste recovery.

As seen in Figure 2, the packaging and plastics manufacturing sector receives the greatest attention from FIs on circularity issues across the value chain.

Figure 2. Proportion of FIs reviewed who had policies addressing the circularity of upstream, midstream, and downstream elements in the sectors listed.

How can FIs support the transition to a circular economy

FIs can drive investments in the circular economy through product and service innovation. Effective strategies include:

• developing financial products including sustainability-linked loans and green bonds;
• participating in industry initiatives to mainstream circular models; and
• engaging directly with clients to implement circular strategies within their operations.

FIs should focus on sectors where circular economy principles can drive the greatest impact and integrate these principles into their risk management processes. Without this alignment, the transition to a circular economy will remain underfinanced, limiting its potential to address systemic environmental challenges effectively.

Useful guidance

The UN Environment Programme Finance Initiative released a guidance document in July 2024 that outlines actions banks can take to support the transition to a circular economy. The document sets out key principles of a circular economy, the current policy and regulatory landscape, opportunities and risks, and case studies from around the world.

Key takeaways

• The circular economy is a critical enabler for building a sustainable future aligned with climate, biodiversity, and pollution goals.
• FIs are pivotal in financing the transition to a circular economy and can help reshape high-impact industries and incentivize innovation in sustainable practices.
• FIs can reduce their risk exposure and help drive the circular economy by focusing on sectors where circular economy principles can have the greatest impact.

Curious about our analysis? 

At ECOFACT we closely monitor ESG developments and the environmental and social risk policies of leading financial institutions. We can help you understand and align with evolving stakeholder expectations. If you need help to adjust your company’s approach to climate change, biodiversity, or human rights, or your engagement with coal, oil and gas, agriculture, chemicals, or other topics, ask to speak with one of our analysts.