Green Investing Isn’t Enough: How Financial Competition Determines What Values Can Achieve

Green finance is often promoted as a way for markets to solve social and environmental problems without heavy government intervention. If households and banks care about climate change, the argument goes, they will naturally shift money toward cleaner technologies. A new study from the International Monetary Fund's Research Department challenges this comforting idea. In a January 2026 working paper, IMF economist Damien Capelle shows that investor values matter, but only when the structure of the financial system allows them to.

The paper asks a simple question: when investors prefer "good" assets, such as green or socially responsible investments, does capital actually move in that direction? The answer depends less on values themselves and more on how competitive the financial sector is, and on whether those values sit with households or with financial intermediaries like banks and asset managers.

Why Competition Matters More Than Good Intentions

The study's central insight is that competition can either amplify or erase ethical investing. In highly competitive financial markets, banks and funds are under constant pressure to deliver strong returns. Even intermediaries with strong environmental commitments risk losing clients if they sacrifice returns for values. As a result, their preferences tend to be "arbitraged away" by competition.

Households, however, face the opposite dynamic. When households care about sustainability and have many intermediaries to choose from, competition works in their favor. Banks must cater to investor preferences to attract deposits, which makes household values more powerful in shaping portfolios. In short, competition strengthens the influence of households but weakens the influence of intermediaries.

This creates a clear divide: competition and household values work together, while competition and intermediary values work against each other.

When Markets Split Into Green and Brown Camps

Not all investors care equally about social or environmental issues, and not all banks are equally committed either. When these differences exist, the paper shows that financial markets naturally split into segments. Environmentally minded households cluster around greener banks that offer lower returns but higher "feel-good" value. More return-focused households gravitate toward dirtier but more profitable intermediaries.

This sorting gives banks more power within their niche. Green banks can follow their values more closely without immediately losing clients. But segmentation also limits the overall impact. Capital shifts within segments rather than across the entire economy, reducing the aggregate effect of taste-based investing.

In other words, green finance may flourish in pockets, without transforming the system as a whole.

Why Preferences Alone Have Limits

Even when some investors strongly favor green assets, market forces push back. As demand for green assets rises, their returns fall. At the same time, dirtier assets become more attractive to investors who care only about returns. These general-equilibrium effects mean that green shifts by some players are often offset by others moving in the opposite direction.

The paper highlights a stark case: if households do not care about environmental outcomes at all, green investment by a single bank is almost fully neutralized by deposit outflows and competing behavior elsewhere. Values held by a minority cannot move the system unless they are widespread or supported by limited competition.

This explains why observed "green premia" in financial markets are small, despite strong public interest in sustainability.

What This Means for Climate and Financial Policy

The same logic applies to government policy. Traditional carbon taxes work regardless of market structure but face political resistance. Financial-sector policies, by contrast, depend heavily on competition. Incentives aimed at households, such as tax benefits for investing in greener funds, work best in competitive systems. Incentives aimed at banks, such as green-tilted capital requirements, work better in concentrated systems where intermediaries have market power.

Using green finance as an example, the paper shows that countries like the United States and Japan, where household environmental concern is relatively strong and banking competition is high, offer the best conditions for taste-based investing to complement climate policy. More concentrated systems rely more on regulation and intermediary mandates.

Perhaps most sobering is the scale of the challenge. Matching the investment impact of a $100 carbon price would require a green return gap of around 10 percent, far larger than what markets currently deliver. Investor values help, but they cannot replace policy.