THE ROLE OF BANKS IN GREEN FINANCE
Climate change has long been considered – with good reason – a risk to the global economy as it is conceived. The Intergovernmental Panel on Climate Change (IPCC), in its annual report, denounces how the efforts declared by countries are not sufficient to keep the temperature rise below the 1.5°C agreed upon during the Paris Agreement.
This trend would increase the risks of serious impacts on the ecosystem and people, which are difficult to reverse. In this perspective, even the economic scenario will therefore be subject to a generalized increase in uncertainty – more or less present, depending on the activities conducted – which will have to be considered in the strategic planning of the various players operating in the global market.
Since the historic decision of COP 21 with the aforementioned ‘Paris Agreement’, the strategic criticality of credit institutions as a conduit for the achievement of global goals has also become increasingly clear. Their financial support could be strategic for the sustainable conversion of existing activities, and the creation of new projects with a view to green development.
In this regard, hopeful signs are coming from one of the key sectors for the economy (and with the greatest environmental impact), the energy sector, which has been the recipient of increased investment in renewable energy over the past few years.
Green Finance, what is it and how important is its impact in the sustainable transition?
The advent of this type of awareness was what defined the birth and development of what is commonly referred to as green finance. According to the World Economic Forum, green finance encompasses ‘any structured financial activity – a product or service – that is designed to ensure a better environmental outcome’. It includes a range of loans, debt mechanisms and investments that are used to encourage the development of green projects or minimize the climate impact of more regular projects. Or a combination of both. Its main objective is to facilitate the transition to a sustainable, low-carbon economy by channeling capital and investment into environmentally beneficial projects, businesses and technologies.
Its main instruments include:
– Green Bonds: bond instruments supporting specific projects with environmental or climate benefits;
– Social Bonds: financing of programs with a positive social impact;
– Sustainability-linked bonds: unlike green bonds, the proceeds received from the bond issue can be used for general and macro purposes related to SDG strategies;
– Transition Bond: liquidity obtained that finances the issuer’s climate transition.
Although climate change is an increasingly pressing issue year by year, the financial world cannot avoid taking into account physical and transitional risk factors that could undermine its stability if underestimated. Physical risks include all natural disasters such as floods, fires, and extreme droughts that increase the uncertainty of business management in normal situations. Transition risks, on the other hand, are related to the speed of development of the green economy. Changes in climate policies, through changes in regulations and technologies, may produce sudden and unexpected revaluation phenomena of assets on balance sheets. This dynamic would lead banks to be more exposed to climate-sensitive sectors, possibly being forced into extraordinary transactions to sell assets deemed too impactful with possible liquidity problems. If, however, this were to happen, it could generate widespread uncertainty and increase the market risk of banks (and the decrease of their strategic importance in the green transition).
The issue is clearly complex. While there is an urgent need to pursue a sustainable transition that requires huge amounts of capital, there is also a need to maintain an economic and geopolitical stability that does not undermine the means of the institutions themselves and ultimately impacts the citizens themselves.
Time, in this balancing act, plays a primary role. Urgent as it may be, the transition can hardly be a matter that can be resolved quickly. This is demonstrated by the fact that it took from 2010 to 2017 for the market value of the main US coal producers to fall by 95%, indicating a significant, though not definitive trend after the COVID-19 pandemic and the recent geopolitical crises.
What banks and financial institutions actually do
Against this backdrop, the European Central Bank itself – which, together with the EU, is particularly attentive to global warming – aware of the aforementioned dynamics, has prepared a strategic plan called the ‘Climate and Nature Plan’ for 2024-2025. This document is specifically dedicated to the study of monetary policy aimed at facilitating the economic choices of credit institutions in terms of green investments. Indeed, the European Commission has estimated that ‘the transition will require additional annual investments of EUR 620 billion until 2030 for the EU to reach its 55 per cent emissions reduction target’.
Although the direction has been clear for some time now, the choices made by financial players have not always been transparent and unambiguous. According to a study conducted by the Bank for International Settlements (BIS), some banks that declare themselves, in their sustainability reports, to be more positive and reassuring in relation to the environmental issues are more inclined to grant loans to the most polluting companies (brown lending), demonstrating a façade behavior. The underlying hypothesis is that some banks may benefit from free-riding by increasing – as far as possible – lending to polluting but also historically more profitable companies. This behavior seems to be reflected in the report ‘Banking on Climate Chaos’ by a collaboration of different NGOs such as Oil Change International, the US environmental organization Rainforest Action Network, sustainability and ethical finance activist BankTrack, grassroots environmental justice group Indigenous Environmental Network and sustainable finance think tank Reclaim Finance. Reportedly, the lack of clarity of decarbonization targets and the efforts of the ‘Net zero Banking Alliance’ is leading to a general increase in investments in the fossil fuel sector and is characterized by more greenwashing behavior.
To these accusations, there was no delay in the response of one of the report’s defendants, the British bank Barclays, accused of being the eighth largest bank in the world in terms of total financing to the fossil sector. Among the points raised in response to the report is the absence of a methodology by which the results are reported, attributing funding values to the different incriminated sectors by considering only cash flows, but not the purpose for which the proceeds are used. In this respect, Barclays repeatedly points out that energy companies are, in fact, also engaged in capital-intensive transition activities. Moreover, it appears that in a survey of multiple institutional investors, almost 50 percent of them say that climate risks have already started to materialize, while only a minority think that the effects of climate change will only come a few years later. Confirming this trend, there is evidence that banks are applying cheaper lending rates to companies with above-average levels of social responsibility (CSR) or clear disclosure of their carbon emissions.
The topic of green finance within the banking sector is ultimately very much alive and well. The parameters by which sustainable investments are categorized within the various sectors, however, also need greater uniformity in relation to the proposed objectives.
It is understandable how difficult it is to pursue a radical transition of the business-as-usual economy while wanting to keep intact the benefits and stability achieved through fossil fuel efficiency.
As popular culture reminds us, however, the blanket is short. While preserving our ecosystem wants (and must!) be the key priority, finding the lowest cost to do so (in the ancient quid pro quo logic) will certainly be one of the global challenges of the coming years.
Article by Marco Pennacchi Griso, Italian Climate Network Volunteer
Relevant references:
2024042957167893.pdf (rassegnestampa.it) > Sustainable finance
2024043057172753.pdf (rassegnestampa.it) > ESG investment results
Do banks fuel climate change? – ScienceDirect > The role of banks in green finance
Mapping the Evolution of Green Finance Research and Development in Emerging Green Economies – ScienceDirect > Fact that China is the country most interested in green finance (intro)