Banks' climate initiatives: a major disappointment

In November 2021, US Treasury Secretary Janet L. Yellen told the COP26 in Glasgow that “the private sector is ready to supply the financing to set us on a course to avoid the worst effects of climate change”. Under pressure to support the economic transition away from carbon-intensive activities – or, in other words, to “align themselves with the climate goals” of the Paris Agreement – financial players worldwide have joined in a series of voluntary climate-related initiatives. They include the Glasgow Financial Alliance for Net Zero (GFANZ), spearheaded by former Bank of England Governor Mark Carney, and billionaire financier Mike Bloomberg.

At the launch of the GFANZ at the COP26, some 100 banks, insurers and asset managers committed to injecting capital worth USD 130 trillion to bring down CO2 emissions and fund the energy transition. Under that commitment, the projects and businesses funded by the loans from signatory financial institutions would have to be “net zero” by 2050, i.e., they should balance the amount of greenhouse gases emitted with the amount removed from the atmosphere. According to the International Energy Agency (IEA), achieving climate neutrality by 2050 will require annual investments of USD 2’000-2’800 billion in clean energy in developing and emerging countries alone. The announcements made in Glasgow by the financial sector elicited high hopes in some quarters... and a healthy dose of scepticism in others.

In a recent study by the European Central Bank (ECB), however, researchers examined the impact of EU banks' voluntary climate commitments – chiefly the Net Zero Banking Alliance, being one of the eight sectoral initiatives making up the GFANZ – on their lending behaviour and in terms of the climate impact of these practices on corporate borrowers. The findings are an embarrassment for the financial players involved.

Profile of signatory banks

The NZBA signatory banks (hereinafter “NZBA banks”) head-quartered in the Eurozone are mega-banks that devote more of their funding to “brown” sectors, with a greater portion of their loans going to the mining sector (including coal, oil and gas), and a smaller portion to sectors classified as “green” under EU taxonomy. NZBA banks' own priority objectives are power generation, oil and gas, and transport.¹ As regards motivation, the study shows that banks are making voluntary climate commitments to boost their ESG (Environmental, Social, Governance) rating and reap reputational and financial benefits, especially when it comes to institutional investors.

The implications for divestment

Sectoral targets represent a voluntary commitment by banks to reducing the emissions they fund by 2030 and 2050, compared to a predetermined baseline. Should the banks choose to meet their targets by divesting, this should mean less funding for the targeted sectors.

The study finds that NZBA banks have cut back their lending to priority sectors by some 20 per cent. At first glance, this would seem to confirm the hypothesis that banks are disengaging from “brown” sectors. But this is not the case. The study found no evidence of reduced investment by NZBA banks – any more than their non-signatory competitors – in priority sectors, or in other high-emission enterprises such as mining companies or companies whose activities are not classified as “green” under EU taxonomy. NZBA banks also did not increase their lending to “green” companies as defined by EU taxonomy after joining the alliance. The study concludes that this casts doubt on the assumption that NZBA banks are actively divesting from “brown” sectors and investing instead in “green” sectors.

No penalties for polluting companies...

The study further shows that the banks' climate commitments have not led to increases in interest rates for the funding of "brown" companies. The observed increase does not exceed 0.25% for priority sectors and 0.55% for the mining sector. Nor do NZBA banks apply lower rates to "green" businesses as defined in EU taxonomy. In other words, the banks neither penalise bad performers nor reward good performers!

... or leverage effect on companies

The ECB study shows that the NZBA has no leverage effect on companies. Indeed, rather than divesting, "climate-aligned" banks can pursue a strategy of "engagement", by pushing corporate borrowers to cut their emissions. They could first insist that the companies to which they lend should set their own climate targets. Indeed, if a company commits to reducing its carbon emissions, the first step is to set a decarbonisation target, which specifies the amount by which the company aims to cut its emissions and the timeline for that reduction. This is tantamount to laying out a climate transition plan.

However, despite the increase in the number of companies that have set such targets since 2018, those borrowing from NZBA banks showed no greater propensity than others to set climate targets. In other words, NZBA banks have no specific climate leverage over companies by way of their engagement.

No impact from voluntary initiatives

Since the signing of the Paris Agreement, financial institutions have announced – with great fanfare – their intention to factor climate considerations into their lending and investment decisions. The findings of the ECB’s first-of-its-kind study brought the lack of impact of the Net Zero Banking Alliance into sharp focus. Although NZBA banks have reduced the volume of their lending in emission-intensive sectors, the "divestment" is no greater than that of non-signatory banks. Moreover, the study is very clear about the outcomes obtained through engagement strategies: corporate clients of NZBA banks are no more active in setting decarbonisation targets than others. The ECB researchers themselves conclude that their study’s findings hold crucial implications for the ongoing debate about "greenwashing" and whether credit rationing by banks can help the global economy realise its net-zero emissions ambitions. As such, there is still every reason for frustration and bewilderment.

From the voluntary to the mandatory

This discussion is now at a turning point. The year 2024 will be decisive in the EU as regards the climate transition plans which financial institutions, too, are expected to formulate. Indeed, such transition plans are central to a new European regulatory architecture, the precise contours of which are yet to be laid out or harmonised.² If they are to be effective, these transition plans must avoid a narrow approach to short- and medium-term climate risk management, and instead encourage banks to reorient their activities in favour of transition. The oversight bodies must be invested with powers, and penalties imposed in the event of non-compliance. An initial step will be taken in Switzerland with the publication – from 2025 onwards – of the first "mandatory climate disclosures“, including by banks, and which are also expected to contain “a transition plan that is comparable with the Swiss climate goals”. Regrettably, the regulatory framework is still imprecise and leaves room for interpretation as to what exactly is required in terms of climate transition plans. These initial reports will therefore have to be carefully scrutinised to gauge the relevance (or otherwise) of this new approach.

The Net Zero Banking Alliance

So far, the most important voluntary climate initiative launched by banks is the Net Zero Banking Alliance (NZBA). It is supported by the UN and comprises 144 members from 44 countries representing some 40 per cent of total assets under management. Several Swiss banks are on board, including UBS (co-founder), Raiffeisen and the cantonal banks of Zurich, Berne and Basel. In signing the commitment, banks undertake to “align lending and investment portfolios with net-zero emissions by 2050”, with “intermediate targets for 2030 or earlier”. These targets must refer to the sectors being prioritised by the banks for decarbonisation, i.e., the most greenhouse gas intensive sectors in their portfolios, and on which the banks can have a significant impact. Furthermore, banks must publish a transition plan explaining how they intend to achieve their sectoral targets. While still at a preliminary stage, the combination of detailed target setting, UN monitoring and outside validation makes the NZBA a stringent, if not the most stringent climate initiative for banks.

¹ Three years after signing, the banks must have set targets for the nine sectors designated by the NZBA, namely, agriculture; aluminium; cement; coal; commercial and residential real estate; iron and steel; oil and gas; power generation; and transport.
² The main aim is to ensure coherence between the approaches of the Capital Requirements Directive (CRD), the Corporate Sustainability Reporting Directive (CSRD), and the very recent Corporate Sustainability Due Diligence Directive (CSDDD).