Banks are under pressure to finance the transition to a greener, more sustainable future, while at the same time remaining profitable. Silvia Pavoni examines how they might achieve this balancing act.
It may be hard to focus on doing the ‘just’ thing in an emergency. The coronavirus pandemic is testing finance and, as the economy dives, there are fears that dealing with the consequences of Covid-19 may result in weaker commitment, at a practical, individual firm level, to long-term sustainability targets that would achieve a more equitable society.
Banks are once again under pressure to both reach those targets and remain solid and profitable. In Europe alone, lenders are set to suffer €400bn of credit losses over the next three years and twice as much should a second strict lockdown be required, according to Oliver Wyman. The consultancy also predicts bank revenues falling by €30bn by 2022 because of lower interest margins and fees. Real interest rates will likely stay low for a long time, as shown by historical data analysed by the International Monetary Fund and addressed by Finland’s central bank governor Olli Rehn.
At the same time, Europe is intent on becoming the first carbon-neutral continent by 2050 – and its banks with it. The European Commission and, unprecedented, the European Central Bank have committed to greener policies. The UK, now leaving the EU bloc, has similar net-zero greenhouse gas emissions targets.
Financing change
How can banks successfully finance this transition and scale up their pre-pandemic environmental commitments? Will they be able to shun those polluting activities that are more traditionally associated with economic recovery and growth and turn a profit from supporting new, often untested models? After the global financial crisis, a decade ago, the opposite happened: energy-intensive measures led to higher emissions. With small entrepreneurs struggling, how can lenders sustainably support local communities?
Academia has made some recommendations. In a report tailored to UK banks, but that is applicable to others, the London School of Economics’ (LSE’s) Grantham Research Institute on Climate Change and the Environment and the University of Leeds’s Sustainability Research Institute propose a series of actions. Both institutes lead the Banking on a Just Transition pilot project, which was launched in 2019 and aims to build a greener, more sustainable economy and society.
The report groups its advice under eight areas, from culture to products to relationship with stakeholders. It suggests that to be able to deliver a climate strategy, banks need to engage with policy-makers, to adjust to specific national requirements and respond to local incentives, and with customers, to respond to their specific issues.
It’s all good advice. In practice, parts of it will prove very hard to achieve. Small business clients have been hardest hit by this crisis and are highly indebted as a result, borrowing an extra $40bn of government emergency funds between March and June in the UK alone. For many, survival is in question as social distancing measures crashed business models while new opportunities for small entrepreneurs remain vague. For some, the transition to a low-carbon economy is another threat that may struggle to become an opportunity at a time of economic crisis. Banks will need to dedicate serious amounts of time and skill to support those clients, particularly in southern Europe, where smaller companies represent a larger proportion of national economies.
A worthwhile cause
Banks can incentivise customers to transition to greener models like few others – but they first need to be convinced of the importance of this transition, either because of mounting public pressure or because of regulation.
A 2020 survey by ShareAction, which the LSE and Leeds universities’ report mentions, has found that “the idea of ensuring a just transition is generally not yet reflected in banks’ climate strategies”. It also discloses that while all European banks which were part of the survey have a climate strategy, just 35% of them align with the Paris Agreement goals.
So perhaps the most poignant recommendation from the two research institutions is the last of the eight: accountability. Progress on banks’ strategy to a just transition and how it translates into their operations should be included in the strategic report that is part of the annual report and accounts. In the UK, disclosures around environmental, social and governance factors are now a requirement of the new Stewardship Code, which came into effect in January 2020.
Banking does serve a crucial function in society. And as society, and scientific evidence, demand a more responsible way to business, banks can do better. But, as an industry, they also need carefully thought-through policy to guide them.
This is a monthly column focusing on ESG principles and how they are reshaping banking, markets and investment. We would like to hear your views on sustainable finance, how it is changing your organisation, your work and your incentives structure. Contact silvia.pavoni@ft.com and, on Twitter, @Silvia_Pavoni
