Keeping faith in net-zero banking in 2023 and beyond

2022 has been a year when climate change has become an even more urgent issue.

Which banks will stand up and really push the envelope for good?

Severe summer droughts, extreme storms and much more have shown how new weather patterns threaten us.

However, the energy crisis caused by the war in Ukraine has made energy security even more of an issue than sustainability, and the poor outcomes from the COP27 summit suggest steps to reduce global warming are getting more challenging and even maybe faltering. Indeed, many commentators are ending the year despondent and in need of new optimism.

Despite all of this bad news, the reality is the business community knows it cannot be complacent about planning for net-zero as decarbonisation targets remain for 2030. Perhaps even more so than governments, the banks and other financial institutions will play an increasingly important role in how businesses achieve these and other ambitious goals around sustainability.

The starting point is how 2023 will see a ratcheting up of ESG reporting and regulatory requirements that hold both banks and their business customers to account on environmental targets. The majority of large companies already publish some form of ESG report. Indeed, most (90%) of the S&P 500 produce some form of ESG report, and now standards are beginning to emerge on what should be reported on a consistent and across the board basis.

Significantly, this is happening on both sides of the Atlantic, with the SEC considering new rules for climate-related risks and greenhouse gas emissions. In Europe, the European Financial Reporting Advisory Group has recently approved the final version of the European Sustainability Reporting Standards. These set out rules and requirements for companies to report on sustainability-related impacts, opportunities and risks under the EU’s upcoming Corporate Sustainable Reporting Directive. These regulatory requirements are well on track to begin applying to all companies with more than 500 employees from 2024.

ESG reporting is an important first step, but taking action and embedding actions into core processes is when change really ignites and delivers. This is where banks are well positioned to play a pivotal role in how both risk and opportunities are understood and managed.

Notably, ESG is really at the heart of a banks’ business when you consider lending, investments and savings. On investments, inflows to sustainable funds have been increasing rapidly from $5bn in 2018 to more than $70bn in 2021, with $120bn in new funds in the first half of 2022, according to Morningstar. Global sustainable assets are now in the region of $2.5 trillion.

For lending, many banks already have products in place on the corporate side such as green bonds, with lending rates reduced for improved environmental rating scores such as CO2 emission reduction. Banks are also moving into the retail space with green products such as green home loans where a reduced rate is applied for housing with better energy efficiency ratings, or personal loans applied to solar panel installation or insulation improvements, for example.

Lending will become an ever more important lever on how business and retail customers make net-zero decisions. Given lending is such a large part of any bank’s business – often representing 50% of profit and similar of their cost base – then there is a huge capability to make a substantial impact.

The influence of banks on promoting sustainable business practices goes beyond lending. For example, on expenditure, a bank can both make environmentally aligned purchases itself and also affect customer spending positively. Some banks have set up links from current accounts to carbon footprint analysis to show the carbon impact of expenditure. Others are looking at how they can evaluate their supply chain and its carbon footprint. This represents another large area of influence and where we can expect to see much more innovation.

As we have learnt from the events of 2022, the journey to net-zero must weather some substantial head winds that could impede, if not knock off course, efforts to address climate change. If banking is all about risk management, then net-zero banking needs an approach that mitigates the risk of not being successful in this, and then leverages any opportunities.

The risk of not tackling global warming is that it leads to more extreme weather events impacting bank customers negatively across their cashflow, let alone impacts on insurance claims. The big issue is that the energy crisis enacted by Russia’s invasion of Ukraine means there is a short-term rush to energy security and the easiest path is using additional fossil-fuel extraction. However, the better example would be to look at funds already being established for the rebuild of Ukraine which will focus on green reconstruction and growth, for example the fund set up by mining magnate Andrew Forrest.

In 2023 and beyond, at every investment or lending stage there will be choices where a bank can help to make a difference. The question is which banks will stand up and really push the envelope for good.

Given the conversations that I had at this autumn’s Sibos event, more banks understand they have a positive role to play. There is a shift underway globally and locally that bank customers, staff and key stakeholders – including regulators – are all part of. For whatever bumps in the road come about, the bigger picture of the risks and opportunities represented by the migration to net-zero is not only here to stay, but growing in importance for the medium to long term. However unlikely it may feel, banks are in the running to be become the environmental movement’s stars over the next few years.