TOKYO -- The Bank of Japan has no shortage of immediate challenges, including the yen's historic weakness and soaring bond yields. Still, it is steadily increasing climate change-linked lending amid debate over whether it and other central banks should be going further in aiding efforts to tackle global warming.

Financial institutions around the world have rowed back on climate action under pressure from U.S. President Donald Trump, but the balance of the BOJ's climate lending scheme has grown steadily over the past five years to reach 24.9 trillion yen ($157 billion) in July, versus an overall balance sheet of about 640 trillion yen. Like other institutions including the European Central Bank (ECB), it continues to support climate actions through monetary and financial policies, such as by monitoring climate risks as well as through providing financial incentives.

Global warming remains a key concern for central banks because its impact on things like agriculture and supply chains through more frequent and intense extreme weather can feed through into inflation, while decarbonization efforts can effect prices, demand and output. Meanwhile, action on climate can provide a signal to the wider financial system.

But with the impact of human-induced climate change -- ranging from last month's devastating flooding on the Nepal-Tibet border to massive wildfires in Europe over the summer -- already visible in the here and now, some are calling for central banks to take more proactive steps. The world is on course to breach the Paris climate agreement's most ambitious target even in the best-case scenario, the United Nations Environment Programme said in a report earlier this month, thereby raising the risk of greater sea-level rise and possibly irreversible changes to things like ice sheets and the Amazon rainforest. The challenge for central banks is that by incentivizing certain projects they could stray beyond their mandates and into what should be government-directed fiscal policy.

The financial sector is generally "based on the idea that it is best to allocate [funds] through the market," said Tomoyuki Shimoda, a specially appointed professor of finance at Rikkyo University in Tokyo and former BOJ official.

The BOJ's climate lending facility, formally known as the Funds-Supplying Operations to Support Financing for Climate Change Responses, was initiated in 2021 amid a global push for stronger climate action, including by the U.S. under then-President Joe Biden. The political backdrop has changed since then, and not just because of Trump. Tackling inflation and strengthening industrial competitiveness are among the priorities of Japanese Prime Minister Sanae Takaichi, leaving the BOJ less room to focus on climate initiatives.

The BOJ's climate lending facility, formally known as the Funds-Supplying Operations to Support Financing for Climate Change Responses, was initiated in 2021 amid a global push for stronger climate action, including by the U.S. under then-President Joe Biden. The political backdrop has changed since then, and not just because of Trump. Tackling inflation and strengthening industrial competitiveness are among the priorities of Japanese Prime Minister Sanae Takaichi, leaving the BOJ less room to focus on climate initiatives. Under its climate-related lending, the BOJ provides one-year loans, which can be rolled over until March 2031, to financial institutions that finance projects or companies addressing climate change.

The program covers loans and bonds associated with labels including "green" -- zero or low carbon -- and "transition," which addresses high-emitting sectors such as steel moving toward decarbonization. The growth in the BOJ balance is largely driven by loans -- Japan's total climate-related bonds peaked in 2023 and have dropped since then. In addition to the lending scheme, the BOJ includes government-issued climate transition bonds in its market operations. It also buys foreign currency-denominated green bonds as part of its management of foreign currency assets.

The program covers loans and bonds associated with labels including "green" -- zero or low carbon -- and "transition," which addresses high-emitting sectors such as steel moving toward decarbonization. The growth in the BOJ balance is largely driven by loans -- Japan's total climate-related bonds peaked in 2023 and have dropped since then. In addition to the lending scheme, the BOJ includes government-issued climate transition bonds in its market operations. It also buys foreign currency-denominated green bonds as part of its management of foreign currency assets. At its September policy meeting, the bank moved the loans to a floating interest rate, which would entail higher levels than the previous fixed rates, and capped lending at 50 trillion yen, or 10 trillion yen for each counterparty.

BOJ Gov. Kazuo Ueda said in a news conference that the changes were made "to ensure stable conduct of market operations while providing stable support for private-sector climate change response." The caps are "not intended to put a brake on" climate finance, he said.

According to Shimoda, a fixed lending rate would risk distorting the market due to a rise in the policy rate and expectations of further rate hikes. Banks could be incentivized to rush to borrow under lower rates with the fixed rate, so it would be better to "steadily build up high-quality projects by making the rate float," he explained.

The caps, meanwhile, might reflect an assessment that the central bank's "fiscal policy element" of allocating resources to certain projects would be awkwardly highlighted on its balance sheet if the BOJ accepted a continuous increase in balance without limit, Shimoda said.

Demand for sustainable finance is strong in Japan, with artificial intelligence investments expected to increase electricity demand, suggested Shunsuke Oshida, head of credit research at Manulife Investment Management (Japan) and a government panel member on transition finance.

"There are demands to develop [renewable energy] where it is possible," he said.

Japan has a commitment to achieve net-zero greenhouse gas emissions by 2050, and to cut these by 46% from levels in the fiscal year that began April 2013 by the fiscal year starting April 2030. The country is not on course to meet the latter goal, according to Climate Action Tracker, a scientific nonprofit that evaluates climate targets. Other central banks also have measures to support climate finance. The ECB, for example, is tilting its corporate bond holdings toward a path aligned with the Paris Agreement's most ambitious target of limiting end-of-century warming to 1.5 Celsius. It also has a program to reduce the collateral value of assets exposed to climate transition risk.

The People's Bank of China, meanwhile, provides discounted credit to financial institutions funding green investment projects. It also accepts green bonds and loans as collateral for monetary policy operations.

For the BOJ, how far it could venture into fiscal policy territory while maintaining alignment with the government's policies has long required careful consideration, not only in its climate response but also in an earlier lending scheme launched in 2010 to support "the foundations for economic growth." In its climate change strategy, the BOJ states that it "deems it appropriate to give consideration to market neutrality, avoiding direct involvement in micro-level resource allocation as much as possible." Such a stance could conflict with calls for a more active role from the Japanese central bank.

For the BOJ, how far it could venture into fiscal policy territory while maintaining alignment with the government's policies has long required careful consideration, not only in its climate response but also in an earlier lending scheme launched in 2010 to support "the foundations for economic growth." In its climate change strategy, the BOJ states that it "deems it appropriate to give consideration to market neutrality, avoiding direct involvement in micro-level resource allocation as much as possible." Such a stance could conflict with calls for a more active role from the Japanese central bank.

In particular, the BOJ should upgrade the climate-lending facility, which currently lets counterparties determine whether a loan supports decarbonization, to include "clearer eligibility, stronger conditionality, and explicit guardrails against greenwashing," Matthew Poggi, a visiting senior fellow at the Centre for Economic Transition Expertise at the London School of Economics and a former economist at the BOJ, wrote in a report published in July by the advocacy group Positive Money. "Although counterparties are required to disclose their guidelines, the absence of fixed standards and inconsistent definitions risks undermining its effectiveness."

The Japanese government does not have a specific eligibility criteria, or taxonomy, opting instead for high-level commitments to net zero and proper oversight of transition plans, thereby allowing for flexibility in how activities can be labeled. In contrast, authorities including the European Union and the Monetary Authority of Singapore have set taxonomies -- for example on energy investments -- to provide clarity on what constitutes sustainable or green investment, with MAS saying that this would "help to reduce the risk of green or transition washing."

"Between having a pure taxonomy ... and having no criteria, there is an intermediate approach in which banks disclose enough information about how they determine whether a loan is transition or green," Poggi told Nikkei Asia. "At some point down the line, it is important for either the [BOJ] or the government to check the results of these loans." Experts say the BOJ could also expand the scope of its climate programs by supplementing an existing annual survey on Japan's climate finance market with a look at how actively commercial banks are engaging in climate lending.

The Monetary Authority of Singapore is among the central banks that have set eligibility criteria for sustainability finance in areas such as energy investments, saying this will "help to reduce the risk of green or transition washing." On the government side, authorities are adding incentives for greater transparency in transition finance through new sustainability disclosure requirements for companies, said Hideki Takada, an official at the Ministry of Finance and a former director of the GX Acceleration Agency, which works to realize investment in decarbonization.

Companies listed on the Tokyo Stock Exchange's Prime market will be required to disclose sustainability information in their annual reports in line with criteria set by the International Financial Reporting Standards, starting for some with the fiscal year ending this coming March. Companies with high carbon dioxide emissions are also required to participate in Japan's emissions trading system from this year and submit transition plans to the government.

More broadly, none of the central banks are using the full array of the tools they have, said Maud Abdelli, global lead for the Greening Financial Regulation Initiative at World Wide Fund for Nature, whether that is targeted refinancing or collateral frameworks. These could also include requiring capital add-ons for exposure to the fossil fuel industry, or pushing banks and insurance companies to engage with clients to obtain data, she said.

Such initiatives could prove to be very influential, particularly through the Network of Central Banks and Supervisors for Greening the Financial System, which had 152 central bank and prudential supervisory authority members as of August.

"The value of central banks in international rule-making is very high" in the financial sector, said Rikkyo University's Shimoda, given international coordination between other authorities is "very weak." He noted that there are few agreements on how to review the credibility of private-sector players that certify carbon reduction impact for company disclosures, or in defining what activities should count as green.

In the meantime, there is still plenty of room for growth under the BOJ's climate-lending facility despite the new 50 trillion yen cap, Poggi said, after a 45% increase in such lending in the year through July.

"The effective shift to a higher rate for banks may slow somewhat future expansion of loans, but given ongoing high demand for green and transition lending, I doubt it will be material," he said.

And for central banks more generally, just keeping climate change on the agenda has a symbolic impact, even if there is room to do more, said Sean Kidney, chief executive of the Climate Bonds Initiative, a nongovernmental organization.

"The central banks are the top of the financial tree. ... When they talk about climate and legitimize the topic, everyone else just has to say, 'We have to talk about it,'" Kidney said. "That is the win."