As investors, governments, and banking customers focus on how financial institutions’ lending and investing activities contribute to greenhouse gas emissions, U.S. banks are increasingly aware of the importance of climate risk. As a result, we see a number of banks taking steps to measure, understand and manage such risk. For example, Accenture research conducted in May shows that almost three-quarters (71%) of U.S. banks can monitor and assess their carbon footprint today, and 67% are prepared to direct capital away from the energy sector to assist in the transition to a low-carbon economy.
Similarly, six major US banks have agreed to align their lending portfolios with the stated goals of the Paris Agreement, and are supplying specific details about how they will accomplish this. One such bank is working with clients that have coal-fired facilities to address the disclosure of greenhouse gas (GHG) emissions. The same bank said it will stop providing financing and/or financing advisory services for companies with such facilities after 2021.
But the industry, as a whole, remains under scrutiny. The problem is that, while banks can control their own policies and actions, they have only limited control over the actions of their clients. Banks have been criticized for contributing to climate change by funding fossil fuel projects (with the 60 largest banks investing $3.8 billion in fossil fuel projects from 2016 to 2020) although they have been redirecting their activities toward climate-friendly ventures. As of May 2021, according to Bloomberg, banks’ $203 billion of bonds and loans to such ventures outpaced their $189 billion of bonds and loans for hydrocarbon-based projects.
Banks still face some significant hurdles in reaching their stated climate risk objectives. One major difficulty is in addressing “Scope 3” or clients’ carbon emissions. While nearly two-thirds (62%) of the banks we surveyed said they are monitoring clients’ emissions and environmental profiles, over a third (35%) said that the availability and granularity of such data is insufficient to assess not only climate risk but the financial risk associated with evaluating lending decisions.
Despite these challenges, this is something that banks will have to get right. Banks are facing what has been described as a major regulatory shift in attitudes toward climate change. French and UK bank regulators are already conducting climate-related stress tests and central banks are incorporating climate risk factors into their oversight, with the Bank of England now taking environmental sustainability and the government’s goal of a net-zero economy into account when purchasing debt. The US Federal Reserve Bank is said to be studying similar actions.
Banks increasingly understand what expectations are being put upon them, but getting there will not be easy, particularly in relation to the accessibility and scalability of relevant ESG data. The magnitude and complexity of the data challenges that lie ahead, including the sheer amount of unstructured non-financial data that will need to be captured and analyzed, is daunting but not insurmountable. We are seeing banks working to develop the data models, analytical tools, and approaches needed to assess their clients’ environmental impact, but this is a learning process. They need to look outside their commitments to the energy industry — to heavily fossil-fuel dependent sectors such as agriculture, manufacturing, construction, and transportation – to have a more complete picture on their portfolio of the climate impact supported by their investments.
Nearly four in ten U.S. banks still do not have a defined approach to measure and assess the impact of transitioning away from fossil fuels to new green energy sources on their financial results. Banks, therefore, will need to step up their efforts to assess how their lending decisions affect their own risks and profitability, in addition to the efforts to assess their clients’ contribution to climate change and climate risk. Looking at the issue through both lenses helps to bring the focus and importance closer to the business agenda of the institution, rather than viewing it as just a “regulatory” or “hygiene” effort.
Addressing these challenges will take time and commitment, but as more stakeholders, including investors and customers, focus on climate change and climate risk there are important implications for banks who can get it right. 73% of U.S. banks we surveyed believe that effectively managing climate risk and promoting the transition to a green economy will help their bank attract talent and customers.