Comment: Transition finance – the banking perspective

Coming out of COP26 in Glasgow, the wind was at banks’ backs to address climate change and finance the transition to decarbonize high-emitting industries.

Over 450 financial institutions made significant public commitments – a combined $130 trillion in capital – to achieve net zero in their financed emissions by 2050. It was hailed as a great moment.

But the best laid plans of mice and men often go awry. The situation since COP26 has become more complicated as the world around banks has shifted.

Unforeseen global crises coupled with consequential national elections have created an uncertain environment surrounding global climate commitments and the feasibility of achieving them.

There is a tension between forthcoming comprehensive sustainability regulation, like the European Union’s CSRD and the SEC’s Climate Disclosure Rule, and waning political support for legislation to meet the UN’s Sustainable Development Goals in the short term. Yet banks still face pressure from environmental activists, shareholders and others to stick to their plans.

Recent comments from Christyan Malek, JPMorgan’s head of global energy strategy, highlight that banks are operating in a vastly different environment: “While the target to net zero is still some time away, we have to face up to the reality that the variables (to phase out fossil fuels) have changed… The $3trn to $4trn it will cost each year come in a different macro environment.”

These challenges come as the science behind climate change paints a more troubling picture.

Global warming has now gone past the 1.5C climate threshold, the magic number at which scientists project potentially irreversible effects of climate change.

A recent study by Germany’s Potsdam Institute for Climate Impact Research found that the global economy is committed to an average income loss of 19 percent by 2049 due to past emissions – equal to a 17 percent reduction in GDP.

Banks now find themselves outpacing sustainability commitments compared to some governments and even their customers.

Our recent research, for example, found that 63 percent of heavy industry executives do not see priority decarbonisation measures being economically attractive before 2030 and that 95 percent believe it will take more than 20 years to deliver net-zero products at close to price parity with high-carbon alternatives.

To make matters worse, many banks lack a clear action plan to effectively operationalise their decarbonisation strategies.

It’s an uncomfortable place to be for banks, made worse by the fact that others in financial services, including insurers, are rethinking net-zero alliances and looking to reset commitments.

The question now is, how can banks navigate this murky regulatory environment? Do they pass the issue to their customers – those in heavy industry and energy-intensive sectors?

Or do they adjust their plans to reflect a slower transition initially and then accelerate later to catch up? And if they do this, how do they manage the potential financial and reputational risks of being seen to backtrack, even if their restated targets reflect the reality of decarbonization in the economy?

The financial sector cannot lead alone. A net-zero industrial strategy in the countries where banks operate, supported by transparent and consistent regulation, will be key to unlocking investment by companies into low carbon assets.

This is not an excuse to allow banks to sit on their hands, but rather the reality of their role in the economy.

Opportunities

All is not doom and gloom here. Banks see massive opportunities in sustainable finance, from NatWest providing £62 billion of climate finance since 2021 to its retail and commercial customers, to HSBC’s $1 trillion commitment to sustainable finance, and Citi being ranked as the top US underwriter of sustainable bonds.

These and others are enabling capital to flow into new, low-carbon technologies whilst managing their exposure to higher-carbon activities.

One of the things that’s plagued transition efforts is the interconnectivity between sectors and the ability to truly deliver change at scale.

In the UK, for example, there’s a disconnect between the sale of EVs, the plans to roll them out further, the infrastructure that is needed to power them, and the power generation to electrify the economy. All of this is done in silos, but banks could help form industrial partnerships and offer governments a programmatic approach that drives greater impact.

The other opportunity for banks lies in solving the age-old problem of quality data. Whilst data is improving, in part thanks to the work of bodies such as the Task Force on Climate-related Financial Disclosures, many banks’ sustainable lending business units are reduced to estimation about their clients’ efforts to reduce carbon emissions.

If banks can bring the same discipline and rigour found in their financial and risk controls to ESG data, then they could embed it into the way they run the bank.

There’s also the opportunity to ensure that it’s a just transition. As industries move capital from high carbon to low carbon, it’s critical to ensure that employees from the high-carbon industries have opportunities to reskill and thrive in a lower carbon economy.

Say you are in a location that has thousands of coal miners; it may be challenging to upskill them all to become solar engineers. So how can you ensure they aren’t left behind, much like what happened to coal miners in the UK in the 1980s.

Banks rely on healthy communities and economies that they can lend and deliver products to, so they have a vested interest in getting this right.

Lastly, banks have to win the hearts and minds of their stakeholders, including employees. It can’t just be a climate or technology journey, but a truly human one. How it engages staff and clients – from the CEO of its biggest corporate down to a retired pensioner who has a bank account – matters.

The banking sector has its critics for not moving capital out of high-carbon sectors quickly enough and for potentially undershooting net-zero commitments.

But it requires the alignment of politics, economic policy, company action and finance if we are to accelerate the path to net zero.

Jon Williams is managing director and global financial services sustainability leader at Accenture