When it comes to climate change, some banks are better than others
You may have heard that one of the most effective things you can do as an individual to contribute to climate transition is to switch banks. But is this really true? What can compel banks to act today? Are some banks doing more than others for the environment? Let's take a closer look.
Christine Marsal, University of Montpellier
In November 2023, in an open letter, nearly 1,200 students from French universities and grandes écoles formally pledged not to respond to job offers from the BNP Paribas group. The reason given? The bank is associated with the financing of a controversial oil and gas extraction project. It was also cited in a report by a United Nations working group published in June 2023. UN experts highlighted the harmful impact on the climate and human rights of the activities of the Saudi company Aramco, which is financially supported by a group of banks including BNPP, which provided a total of $7.6 billion between 2016 and 2022.
So should we avoid this banking group in order to combat climate change? Are other banks doing better? Let's take stock of the situation.
The role of the financial industry in climate change
The banking sector is increasingly under scrutiny for its role in climate inaction.
Article 2 of the Paris Agreement highlights the central role of the financial industry in reducing greenhouse gas emissions. In particular, it sets as a priority the need to make "financial flows consistent with a pathway towards low greenhouse gas emissions and climate-resilient development."
Beyond the Paris Agreement, there are growing constraints on the banking sector that are contributing to several notable changes. But these new rules of the game remain "too little, too late" for a number of environmental activists.
To try to assess this, let's start by looking at what constraints banks face today.
What can constrain a bank today?
Banks are subject to regulations that cover all aspects of an organization's operations: human resources, information systems, customer management, financial management, etc. These regulations are strongly influenced by principles of prudence that all bankers must observe.
It is summarized by the work of the Basel Committee, which brings together representatives from central banks in 45 countries, including the EU, and whose recommendations are implemented within the European Union by the European Central Bank. In France, the Banque de France acts as a relay for European policy via the Prudential Supervision and Resolution Authority (ACPR).
If a bank fails to comply with mandatory ratios and procedures, it may be fined or have its license revoked (the bank must close). Its executives may also be held liable.
What penalties are possible?
To ensure compliance with these obligations, the banking supervisory authorities in each country carry out regular checks within the institutions themselves. If irregularities are found, disciplinary measures may be taken by the ACPR. The withdrawal of authorization remains rare but is a powerful deterrent: in 2010, this was the case for a European private management company, and in 2019 for a currency exchange company. Prohibitions on conducting financial activities (insurance brokerage, manual currency exchange) are more common: three in 2012, one in 2014, and three in 2022.
Fines can be very steep. In 2018, for example, a $50 million penalty was imposed on Banque Postale, whose anti-money laundering and counter-terrorism financing (AML/CTF) procedures were deemed non-compliant.
No penalties imposed for failure to address climate risks
And what does the Basel Committee say about climate change? Since 2018, it has recognized that credit risk is linked to climate risk. This recognition has led all credit institutions to review their credit risk management policies: new criteria to be taken into account in financing agreements, climate risk included in the work of the audit committee, training of bank directors in climate risks, and the implementation of climate risk stress tests in the medium term.
However, to date, no penalties for non-compliance with climate risks have been imposed on any French institution, as the standards are still being developed.
A new constraint: the green asset ratio
However, in its annual work program,the ACPR plans to closely examine the transition plans undertaken in the banking sector in 2024. This involves monitoring the climate commitments published by banks under the Climate Energy Act and the European regulation (SFDR). From 2024, banks will have to publish a new ratio (the green asset ratio or GAR), which consists of calculating the share of green assets (environmentally responsible financing and investments) in their total assets. In the case of BNPP, the investment in Aramco, mentioned in the introduction, contributes to a deterioration in this ratio (this financing reduces the green share of the bank's assets). It will now be easier for citizens to find out about the investment policies followed by particular banks. https://www.youtube.com/embed/hxsplC0xPlY?wmode=transparent&start=0 Report by Le Monde on the links between Aramco and BNP Paribas.
However, several institutions have anticipated the publication of the GAR; for example, some regional branches of Crédit Agricole have been publishing this ratio since 2021.
The EU requires banks to disclose the carbon footprint of the investments they offer
On the EU side, since the launch of the European Green Deal, banks have been preparing to respond to new regulatory constraints. Since 2022, banks have been required to disclose the carbon footprint of the investments they offer to their customers. This seemingly innocuous measure nevertheless conceals paradoxical and potentially conflicting situations. Take, for example, a customer who 15 years ago subscribed to shares in a "family man" type mutual fund, i.e., one considered risk-free. However, the financial products that make up this fund may come from polluting industries. In 2024, this "good" investment will therefore become a "bad" investment because of its climate footprint. If the customer decides to change their investment, they may incur losses. If this happens, the bank will be accused of giving bad advice.
This situation therefore encourages institutions to exercise caution. Caution that can sometimes be seen as unwillingness on the part of banks. https://www.youtube.com/embed/40vLspK1UAs?wmode=transparent&start=0
But beyond the need to comply with new regulations, other motivations may prompt banks to change their practices: the threats that climate change poses to finance, and customer expectations.
Why banks have legitimate concerns about climate change
Climate change is in fact considered a risk that could affect the economic and financial stability of entire geographical areas. Take, for example, a regional bank specializing in agricultural financing. Climate change (drought/flooding) leads to a loss of income for customers, which in turn leads to defaults. However, the bank remains a financial intermediary; it lends money that does not belong to it (from customer savings accounts, for example). In the event of mass defaults by its agricultural customers, it will have difficulty repaying its savings customers. At the same time, in accordance with the prudential principles of regulation, the bank will turn away from the agricultural sector, which has become too risky. The investments needed for the climate transition of this sector will then be frozen, exacerbating the initial difficulties.
However, taking climate risk into account at the individual portfolio level (as described above) is still considered too timid. The Veblen Institute, a French think tank that promotes public policies in favor of ecological transition, proposes a sector-based approach to remedy this. This involves, for example, prohibiting financing for entire sectors (mining, oil extraction, etc.). These objectives are already included in international alliances such as the Glasgow Financial Alliance for Net Zero, to which all major banks have signed up. However, this alliance has set itself the target of 2050 to achieve this, which is deplored by the main NGOs.
Internally, what changes?
On the banking side, some institutions are innovating and seeking to improve existing tools to integrate climate risk into their risk management. Between 2018 and 2019, Société Générale increased its climate risk management staff by 50%; the CASA group (Crédit Agricole) is measuring the level of expertise of its directors in the climate field and introducing climate risk into its credit risk assessment.
It is also worth noting that no French bank appears in the list of the 12 banks most involved in financing hydrocarbons. In this ranking, Banque Postale is considered the most virtuous, ahead of Crédit Mutuel and Crédit Agricole. However, Crédit Mutuel has announced that it will step up its efforts in this area by refraining from financing companies listed by the NGO Urgewald.
Other institutions are developing tools to better measure the carbon footprint of financed projects (Crédit Agricole), or implementing methodologies to better analyze environmental risks. However, institutions face difficulties in collecting more non-financial data from their customers. Internal processes are not yet operational for collecting such data on a large scale (quality of industrial projects in terms of ecological transition, environmental impact of these projects, etc.). This difficulty is illustrated by the AMF's recent proposal to review disclosure standards by advocating a clarification of concepts such as "sustainable investment," for example.
The next regulatory step will be to verify that the information disclosed by banks corresponds to reality and to impose penalties when this is not the case.
Can customers help banks go green?
In the meantime, banks may also be motivated to green their balance sheets in order to meet their customers' expectations. However, an exploratory study conducted by management science researchers De Lanauze and Siadou-Martin shows that customer demands remain ambiguous. "The perceived environmental concern of banks is not a major expectation for consumers," they note, adding that, nevertheless,
"Consumers support and even encourage banks' environmental actions and communications."
These researchers therefore believe that these actions remain beneficial for banks, provided that two fundamental principles are respected:
"Environmental communication must be based on facts, i.e., it must reflect a genuine commitment (requiring transparency and truthfulness) and not neglect the core business of banking services."
Neobanks have understood this well, and Hélios and Green-Hot, for example, communicate extensively about the intermediation circuit that will be put in place: the savings collected will never be allocated to projects that are harmful to the planet. Even if we consider that the reduction in financing for disproportionate extraction or exploitation of forests is too slow, the movement is real. However, it may sometimes seem insufficient, given, for example, the consumption forecasts for the digital industry (GAFA, Fintech, and other digital establishments), whose carbon footprint remains largely ignored.
Christine Marsal, Senior Lecturer, Management Control, Bank Governance, University of Montpellier
This article is republished from The Conversation under a Creative Commons license. Readthe original article.