Banking on better financial lending to combat climate change

Banks can play a pivotal role when it comes to regulating financing businesses in the battle against climate change.

As the world looks beyond the COVID-19 pandemic, and to building back better, it is fast becoming clearer that a changing climate, nature loss and the pandemic —are inextricably linked and compounding to the current global economic crisis. And that the only measure of assurance towards a more stable economic recovery lies in combatting climate change actively. This means curbing carbon emissions, moving towards more sustainable business practices, to consider the environment and local communities as stakeholders within the business.

While business is key to combatting climate change, it stands to reason that banking too has an integral role to play going forward when it comes to regulating financing businesses and in the battle against climate change, most specifically in the form of overhauling bank capital rules.

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Banking on stricter financing routes

A survey carried out by the non-profit Climate Safe Lending Network, asked academics, commercial banks, investors, non-governmental organisations and central banks to rank 10 proposals for how financial regulation could be changed to boost climate efforts. The respondents included the Bank of England, the European Central Bank and Spain's BBVA, as well as Boston Common Asset Management and Amalgamated Bank in the United States, and the UK's Big Society Capital.

The proposal drawing the most support was for regulators to impose tougher rules around the amount of capital banks need to keep as a buffer if they want to lend to companies responsible for emitting high levels of greenhouse gases.

On a scale of 1 to 5 assessing the potential impact of the policy proposal, with 5 the highest, the survey respondents rated it 4.13. The feasibility of its implementation was rated 0.3 on a scale of minus 1 to plus 1, with plus 1 most feasible.

"Stranded assets create a credit risk that is not captured by the current framework," said Andrew Turvey, prudential risk director at Belmont Green Finance Limited.

Sarah Breeden, executive director for UK deposit takers supervision at the Bank of England, however, said more clarity was needed on the path of forward climate policy for the option to be more feasible.

"We would have better sight on how risks might arise and more data to support policy change," she said.

The next most backed proposal was for regulators to set out a clear framework for what it means to be compliant with reaching net-zero emissions by mid-century, and in line with the goals of the Paris climate agreement.

"This is the type of guidance that could be a game changer," said Lauren Compere, managing director of Boston Common Asset Management. The proposal was ranked 4.0 on potential impact and 0.3 on feasibility.

The story in India

An article by S&P Glob, states how the global sustainability disclosure platform CDP has been lobbying banks to measure and disclose the risk climate change may pose to their portfolio in India. Based on the information submitted by some of the biggest lenders, including the State Bank of India and HDFC Bank Ltd., CDP found nearly $84.4 billion of debt at India's leading financial institutions was at risk from extreme weather events such as droughts, floods and cyclones.

The problem lies in the fact that banks can lend to fossil fuel companies relatively cheaply because the risk-weights applied to the lending do not take into account the systemic risks of doing so. By making it more expensive to lend to these companies, banks would lower their exposure to the risk, build up capital buffers to absorb potential losses from any loan defaults and focus investment on other parts of the economy. The Indian government and several companies have taken steps to commit themselves to science-based greenhouse gas emission targets required to limit global temperature increase to 1.5ºC-2ºC compared with pre-industrial temperature levels.

India now leads emerging economies for having the maximum number of companies committed to such targets and is at the sixth position globally. According to CDP, the number of companies committing to these targets rose 37 per cent to 52 in 2020, but more needs to be done.