Translating banks’ climate commitments into action: going green isn’t always black and white

November 30, 2021

An article by Ricardo Martinez, Principal | Deloitte Risk & Financial Advisory; Michelle Bachir, Senior Manager, Sustainability and ESG services | Deloitte & Touche LLP; Akshatha Shetty, Senior Manager, Deloitte Risk & Financial Advisory | Deloitte & Touche LLP; Val Srinivas, Research Leader | Deloitte Services LP and Jill Gregorie, Senior Market Insights Analyst | Deloitte Services LP

As the recent United Nations Climate Change Conference (COP26) highlighted, countries and private sector entities have become more ambitious in their commitments to alter the course of climate change.

Climate pledges are heating up in the global banking industry as well, particularly among the large US banks. For instance, a handful of the largest US banks have collectively agreed to contribute at least $3.5 trillion to sustainable initiatives over the next decade.¹ Not only does this figure represent more than one-third of these five banks’ total asset base in 2020, but the sum of these new pledges is roughly five times what the banks spent on climate change programs between 2007 and 2020.²

These large US banks have also joined the Net-Zero Banking Alliance, a group committed to “aligning their lending and investment portfolios with net-zero emissions by 2050.”³

Of course, banks can’t alter the trajectory of climate change on their own. Experts estimate that the world needs to invest $131 trillion in the energy transition technologies through 2050 to limit global warming to less than 1.5°C.⁴ At COP26, more than 450 global banks, insurers, and asset managers joined the Glasgow Financial Alliance for Net Zero (GFANZ), a coalition capable of generating $100 trillion for green investments over the next three decades.⁵

But the harsh reality is that the planet remains on track to surpass the 1.5°C threshold before 2040.⁶ So, more urgent and coordinated action between governments, businesses, and professional associations is needed now.

The banking industry stands out from other sectors in their capacity to help companies transition to a carbon-neutral economy by using their balance sheets for lending, investing, and trading activities. But effecting change at scale will likely require extensive collaboration with clients and regulators. There are some indications of progress on this front: for the first time since the Paris Agreement was signed in 2015, global banks are on track to provide more financing to green projects this year than to oil, gas, and coal companies.⁷

What more are banks doing to fight climate change?

Banks are not just providing capital to firms that are piloting climate change innovation. Other activities include advising clients on the transition to net-zero, including mergers and acquisitions of greener companies, asset disposal, and financing of green projects. Institutions are also developing financial instruments that promote environmental initiatives, such as thematic investments and target-linked bonds, as well as new platforms that make it easier to buy and sell carbon credits or participate in carbon markets. Many banks are also updating their policies regarding the financing of emission-heavy activities, such as fracking and Arctic drilling.

In addition, U.S. banks are working to catch up to European institutions that tend to be more advanced in green banking practices such as climate-related stress testing, green bond underwriting and the development of innovative products like sustainability-linked derivatives and exchange traded instruments. Some banks are also beginning to factor in executives’ performance on climate and other ESG targets into executive compensation practices.⁸

Another contribution is intellectual capital, which banks have been channeling towards technology that should be made commercially viable, such as hydrogen energy, waste-to-energy, and carbon capture, utilization, and storage (CCUS). Some banks are also leveraging their influence with policymakers to facilitate coordinated action on climate, and press for legislation on carbon taxes and other climate matters. There is also a movement to bring low-carbon technology onto open platforms. For example, some banks are making the patents they use to reduce emissions at energy-intensive processing sites available to the public,⁹ and others have joined coalitions that share tools and datasets that can assist with climate risk modeling and scenario-based predictive analytics.

This article discusses some of the important actions banks should pursue, the challenges they will likely confront, and the questions they should consider to deliver on climate commitments.

The challenge: Lack of standards

While banks’ investments in net-zero initiatives are certainly notable, details about how most banks will execute emission-reduction plans remain sparse. While many companies in financial services and other industries have taken strides to share more details about their climate initiatives, the private sector has not yet agreed upon a standard framework for measuring carbon footprint or determining which parts of the value chain should be the focus of decarbonization efforts. As a result, it can be difficult for outsiders to assess how firms are advancing on their climate goals, or compare the progress of peer institutions.

This lack of standardization may leave firms vulnerable to accusations of “greenwashing” from a wide range of stakeholders, including consumers, activists, shareholders, investors, regulators, and the press. Many stakeholders are pressuring financial institutions to be more transparent about their plans to phase out of fossil fuel financing, and in some cases, are demanding banks go beyond the obligations laid out in their climate pledges.

Institutional investors, for example, have launched shareholder campaigns that would compel banks to publish short-term decarbonization targets sooner than they’ve already committed to, and exit certain emission-intensive sectors by a set date. They are also pushing banks to develop a strategy for quantifying their contributions to biodiversity loss and other nature-related risks.

Even some courts are pushing for more immediate action. For instance, a German court recently ruled that insufficient interim targets can result in a lion’s share of the work being punted down the line instead of being treated with the urgency they require in the near-term.¹⁰ This decision resulted in a law that created stricter reduction targets across public and private sector institutions.

Some activists are also urging financial institutions to prioritize actions that will reduce and eliminate emissions, instead of just offsetting them to meet net-zero ambitions. These groups point out that banks can meet their targets and still finance fossil fuel producers, so long as their activities are supplemented with carbon capturing, geoengineering, and other carbon-offsetting technologies. Defending against these claims can be hard when banks have no widely accepted guidelines to fall back on, leaving businesses to point to their own targets for accountability.

How to operationalize banks’ climate pledges

There are several areas where more clarity is needed to understand how banks’ pledges will be operationalized and reported on, especially in shorter increments over the next decade.

Most large U.S. banks are taking steps to be more accountable on their portfolio goals, in particular by disclosing the methodology they will use to calculate portfolio emissions, and deciding which sectors to prioritize for decarbonization. The use of carbon intensity, a metric that considers emissions relative to units of output, is emerging as a viable approach to evaluating performance against decarbonization trajectories, and revising targets over time. This metric can be more inclusive of smaller companies, since it accounts for growth. But some groups argue that it is not as effective as absolute emissions, and suggest that companies can shift resources around to lower emissions intensity without impacting their total production of greenhouse gases.

Banks can also do more to build out non-financial disclosures. One step that firms often overlook is quantifying the financial value associated with the expected benefits of financing green projects, despite the benefits it has in boosting reputations by showing the positive externalities of their work.

New demands from financial regulators may also spur banks to build out their disclosures. The Securities and Exchange Commission, for example, wants leaders to reveal how they’re managing climate-related risks and opportunities, and incorporating those analyses into corporate strategy.¹¹ And the Federal Reserve is developing scenario analyses that will model the impact of climate-related risks on individual institutions and the financial system as a whole.¹²

Banks can also refine climate risk reports, and do more to incorporate recommendations set forth by the Task Force on Climate-related Financial Disclosures (TCFD) and Sustainability Accounting Standards Board (SASB). These frameworks are widely considered to be the “gold standard”¹³ of climate risk reporting, and countries including China, New Zealand, Switzerland, and the UK have made them mandatory.¹⁴

U.S. banks have gotten better at embedding TCFD and SASB recommendations in their sustainability reports, but they can do more to make climate communications accurate, complete, and reliable in the heightened attention to net-zero reduction targets. Third-party assurance providers can assist with governance, oversight, and data management processes, and verify that climate reports are market-ready.

As highlighted above, banks should confront a wide range of questions to determine how to maximize the impact of their substantial climate commitments, while delivering tangible results that can be measured and tracked. When choosing next steps, they should consider the following:

1. What metrics should be used to establish trajectories, and monitor progress towards interim goals?
2. How can reporting be enhanced and/or substantiated to demonstrate accountability and develop safeguards against greenwashing claims?
3. Who within the banks should be tracking financial commitments to climate change, and which external groups should verify that progress reports are accurate?
4. How should financial commitments be revised as new information about climate science comes to the surface? Could pledges be adjusted over time?
5. What financing activities might have the biggest impact on emissions reduction, and how can they be prioritized?
6. Where and how might funding for decarbonization and green investments happen? Will there be an impact on banks’ capital and liquidity levels?
7. How can banks better track and measure emissions by their clients/borrowers? And what methodology should be used to determine which sectors should be targeted?
8. What data is still required to track the greenhouse gases emitted by portfolio companies?

Endnotes

1. Rachel Koning Beals, “Major banks freshly pledge trillion-dollar spending on climate change but remain scrutinized for oil-patch financing,” MarketWatch, April 15, 2021.
2. Deloitte Advisory analysis of six banks’ actions on sustainable finance between 2007 and 2021.
3. United Nations Environment Programme Finance Initiative, “Net-Zero Banking Alliance,” accessed on November 3, 2021.
4. The International Renewable Energy Agency (IRENA), “World Energy Transitions Outlook: 1.5°C Pathway,” 2021.
5. Glasgow Financial Alliance for Net Zero (GFANZ), “Amount of finance committed to achieving 1.5°C now at scale needed to deliver the transition,” press release, November 3, 2021.
6. Richard Allan, et al., “Climate Change 2021: The Physical Science Basis,” Intergovernmental Panel on Climate Change, August 7, 2021.
7. Mathieu Benhamou and Tim Quinson, “Banks always backed fossil fuel over green projects—until this year,” Bloomberg, May 19, 2021.
8. Amalgamated Bank, “Corporate Responsibility,” accessed October 14, 2021.
9. Low Carbon Patent Pledge, “JPMorgan Chase, Micro Focus, and Majid Al Futtaim join the Low Carbon Patent Pledge to accelerate climate solutions,” press release, October 7, 2021.
10. “How to make long-term climate pledges add up,” The Economist, May 8, 2021.
11. Gary Gensler, “Prepared remarks before the Principles for Responsible Investment ‘Climate and Global Financial Markets’ webinar,” U.S. Securities and Exchange Commission, July 28, 2021.
12. Lael Brainard, “Building Climate Scenario Analysis on the Foundations of Economic Research,” presented at the 2021 Federal Reserve Stress Testing Research Conference, October 7, 2021.
13. “Larry Fink rules on the best global standards for climate risk reporting,” Financial Times, January 20, 2020.
14. Graham Caswell, “G7 nations agree on mandatory climate-related disclosure,” Green Central Banking, June 8, 2021.
15. Kiran Vasantham, et al., “Institutional Investor Survey 2021,” Morrow Sodali, May 11, 2021.
16. Deloitte Insights, “Building credible climate commitments.”
17. Avery Ellfeldt and E&E News, “What is wall street’s role in climate?,” Scientific American, March 31, 2021.
18. Don Jergler, “U.S. financial services leaders support principles for low-carbon transition,” Insurance Journal, February 28, 2021.