Sustainable finance is essentially defined as the lending and investment decisions of asset owners that take into account the ESG impact of an economic activity.
Banks can drive change by financing the right projects and empowering businesses, society and people who want to accelerate the green transition. And banks play a central role – without their active participation, the path to a sustainable world and social equality will be more complicated, if not impossible.
- The UN summoned
Net-Zero Asset Owners Allianceis an alliance of approximately 70 financial institutions, including banks, fund management companies and insurance companies, with more than $10 trillionin assets under management. The alliance has committed to transforming its investment portfolio to net zero greenhouse gas (GHG) emissions by 2050, in line with what is needed to achieve a maximum temperature increase of 1.5 °C compared to pre-industrial levels.
- exponential growth in green bond market has happened since its inception in 2007, and by
December 2020cumulative emission exceeded 1 trillion dollars. These bonds are created to direct capital flows to projects and economic activities that have positive environmental benefits.
- Banks, other financial institutions and regulators have begun integrating ESG factors in their business as well as in their operating models. This means improving their loan portfolios to include ESG factors as a core component of credit risk measurement and management. It also leads to sending strong and positive messages to corporate clients (both public and private) looking to access capital. The aim is to redirect capital from high-emitting sectors to green sectors.
- Conscious consumption is on the rise, and consumers believe in tying their purchasing decisions to a potential brand’s environmentally responsible sourcing, production, packaging, and distribution processes, in addition to ethical values.
- Incentives for sustainability, such as tax breaks and rewards, as well as penalties, such as higher lending rates, should soon become regulatory obligations. 2022 could be an inflection point beyond which financial services firms may feel increasing pressure from regulators to comply with green standards.
The commitment of European banks to the goals of the Paris Agreement has resulted in numerous green business initiatives. Banks have started supporting their customers and employees with green initiatives and making their underlying collateral more sustainable:
- Íslandsbanki has partnered with
Menigaprovide its customers with an accurate carbon footprint for each transaction. ABN AMRO Bankhas developed an energy saving tool allowing customers to display their options to reduce their energy consumption. West Bank(part of BNP Paribas) launched a green current account. Rabobankfacilitated green entrepreneurship through different types of sustainable loans, including green loans, impact loans and innovation loans.
- BBVA has launched recycled plastic cards, and
CaixaBanklaunched a line of biodegradable gift cards.
- There are several green mortgage products available from major banks including Barclays,
INGNordea and Societe Generale.
- Deutsche Bank launched a green IT initiative that resulted in energy savings of 76% per person, savings of 4.5 million kWh of electricity per year, reduction of paper used by 25% and quadruple the energy efficiency of the bank’s data centers.
Initially, European banks offered these green business initiatives mainly in response to growing demand from society. Subsequently, however, an increasing number of sustainability-related regulations were introduced by regulatory institutions. In introducing these new regulations, regulators have also highlighted the role of banks as one of the key players with a responsibility to help create a more sustainable world. This development has resulted in a situation which, alongside social pressure from society and the intrinsic motivation of banks, now forces banks to focus more on initiating sustainable business initiatives.
It took some time for regulators to finalize the concrete regulatory requirements related to sustainability. Over the past decade, regulators have mostly shared ideas and working papers on the subject. Gradually, especially in recent years, the initial ideas have evolved into more concrete regulations and guidelines with which banks must comply.
Figure 1 shows a timeline with an overview of some of the latest developments in sustainability-related regulations, with their corresponding dates.
Many other important regulations were created during this time, some of the most notable being:
- The Non-Financial Information Directive
EUSustainable Finance Disclosure Regulation EUlabels for benchmarks (climate, ESG) and ESG communication of benchmarks
- The Corporate Sustainability Reporting Directive
- ESG measures AIFMD, UCITS and MiFID (Markets in Financial Instruments Directive)
- And many more.
Since sustainability-related regulations are relatively new to banks, many regulatory requirements in this area have yet to be enacted by regulators. We expect that in the coming years more concrete regulations will follow the previously mentioned regulations. These regulations must in particular concern:
- Uniform definitions of environmental, social and governance (ESG) risks, including for physical risks and transition risks.
- The development of appropriate stress tests and scenario analyzes for the assessment of the impact of ESG risks on the financial stability of banks.
Challenges for banks
- Banks follow theirs individual approaches to integrate climate objectives into their activity, which is becoming an essential business process. To align their loan and investment portfolios with the goals of the Paris Agreement, banks are obliged, for example, to determine the greenhouse gas emissions associated with their clients’ economic activities and related projects that they they fund.
- In addition, banks must compare emissions with science-based benchmarks and set time-bound emission reduction targets to align the emission profiles of their loan and investment portfolios with these benchmarks.
- As mentioned earlier, banks have launched various green business initiatives to achieve a common goal: to create a more sustainable world. To achieve this goal, banks use a sectoral approach. This implies that each sector has its own transition path, or technology roadmap, to contribute to a more sustainable world. For the different sectors, the banks have piloted and tested different scientific methods to measure their performance in achieving this objective and to compare their performance using multiple benchmarks.
- The objective measurement and benchmarking bank performance is one of the many challenges banks face in this regard. The main disadvantage of the different performance measures and benchmarks used in banks is that it is difficult to compare which is the most optimal approach for banks. The main reason why banks may use different measurement methods and benchmarks is that there is not yet a single global standard or method available. The main common factor between the different performance measurement methods and benchmarks is that they depend on each sector, with their own corresponding global climate goals and ambitions.
- Finally, the availability and accuracy of sustainability data remains a challenge for banks. Although this has improved considerably in recent years, it is still an area that requires special attention, particularly for banks to be able to carry out scenario analyzes and to monitor and report on the performance of their portfolios in terms of sustainability and potential (future) climate risks.
How can we help?
- Our specialists can assist banks by interpreting existing or new regulations in the field and can also translate these regulations into policies and practices.
- Additionally, our experts are ready to assist banks by performing gap analyzes and leading or assisting with the necessary implementation processes for relevant regulations.
- Our specialists can develop stress tests and scenario analyzes related to SFR, integrate ESG factors into banks’ risk models and measure the corresponding impacts.
- Financial sustainability and ESG regulations have led to a massive increase in regulatory reporting for banks. This increased load can be handled by specialists trained in
Interested in our thoughts on the next generation of climate-related stress testing? Check out our article on climate stress tests: