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Banks Face Dual Challenge on Climate Policy

Around 90% of EU banks are exposed to climate transition risks, recent analysis from the ECB shows. 

Banks globally are increasingly feeling two-pronged pressure from regulators and investors to up their climate ambition and stop financing fossil fuels. 

In recent months, European banks have fallen under heightened scrutiny from the European Central Bank (ECB) on their climate disclosures and target-setting, while North American banks enter the 2024 proxy season with climate-focused resolutions added to the ballot by pension funds.  

“The current steps banks are taking to address climate risks only skim the surface of what is needed,” Xavier Lerin, Senior Research Manager at UK NGO ShareAction, told ESG Investor. “Most banks’ fossil fuel policies focus on a small portion of their financing – the direct financing of new oil and gas assets – and fail to capture the vast streams of capital going to companies developing these assets. They should now clearly show their intention to restrict financing for companies unwilling to transition, starting with those focusing exclusively on oil and gas exploration and production.” 

Too often, banks are not demonstrating suitable ambition, Lerin suggested. 

Despite publishing a 2022 energy policy pledging to end funding for new oil and gas fields, HSBC has come under fire in recent weeks for having reportedly helped the oil and gas industry raise an estimated US$47 billion.  

More recently, Bank of America updated its Environmental and Social Risk Policy Framework, weakening its sustainability-linked policies. These previously stated the bank would not directly finance oil and gas projects in the Arctic, new or expanded coal-fired power plants, and new or expanded thermal coal mines. Those projects will now go through “enhanced due diligence”, the revised framework mentioned, as opposed to being placed under the “business restrictions” category – normally reserved for activities that the bank does not engage in. 

“Banks have a critical role to play in driving the transition away from financing fossil fuels and need to radically change their practices to deliver this,” said Rémi Hermant, Financial Institutions Policy Analyst at NGO Reclaim Finance.  

According to the International Energy Agency, annual financing to the renewable energy sector needs to double from US$2.8 billion to US$4.7 billion by the end of the decade to remain Paris-aligned. Annual investments in fossil fuels would also need to fall by 60%.  

Laying out the law 

Last month, the ECB set out its strategy for 2024-25, which included the expansion of its work on climate change.  

The central bank said it would assess over the next 12 months the impacts and risks of the climate transition for banks – including how increasing physical risks and negative impacts stemming from nature loss and degradation interact with climate risks. 

It will also intensify its work on the effects of transition funding, green investment needs and transition plans, exploring the case for further changes to its monetary policy instruments and portfolios.  

These announcements followed the ECB’s third assessment of European banks’ progress on the disclosure of climate and environmental risks. The central bank found that while most banks had expanded their climate and environmental disclosures, the quality of that information remained too low.  

Additional analysis from the ECB covering 95 banks suggested that 90% of them were exposed to climate transition risks. Seventy percent also faced elevated litigation risks, as they were publicly committed to the Paris Agreement but had failed to align their credit portfolios.  

The EU’s revised Capital Requirements Directive (CRD VI) includes a legal requirement for banks to prepare prudential plans that address climate and environmental risks arising from their transition efforts. Banking supervisors have also been mandated to check these plans and can require that banks reduce their exposure to climate and environmental risks.  

“The ECB’s [climate and environmental] expectations themselves remain vague and the impact of their rules is difficult to evaluate,” said Paul Schreiber, Senior Policy Advisor at Reclaim Finance. “So far, no mandatory rules have been set to shift financial flows and ensure that banks have a real impact.” 

To be truly robust, Schreiber said bank rules would need to mandate climate transition plans, Schreiber argued. They should include criteria cutting support to fossil fuel development, identify a clear definition of greenwashing and minimum criteria on all sustainability-themed products, funds and ratings, and introduce capital requirements for fossil fuel assets. 

Golden ratio 

Meanwhile, North American banks are under mounting pressure from US shareholders to transition away from financing fossil fuels. 

Last month, New York City Comptroller Brad Lander and the trustees of three New York pension funds filed shareholder proposals at several banks, calling for regular disclosures of clean-energy-to-fossil-fuel-financing ratios. Providing this metric is essential to fully measure a bank’s equity and debt financing of fossil fuel companies and projects, the pension funds argued. 

The banks targeted by the shareholder proposal include Morgan Stanley, Bank of America, and Goldman Sachs. 

“We fully support the New York City (NYC) bank campaign to ensure a 4-to-1 ratio of financing between clean energy and fossil fuels,” said Danielle Fugere, President and Chief Counsel for US shareholder advocacy group As You Sow.  

As You Sow’s proposals are aligned with those put forward by NYC’s Employees’ Retirement System (NYCERS), Teachers’ Retirement System (TRS), and Board of Education Retirement System (BERS). 

According to Agathe Masson, Stewardship Campaigner at Reclaim Finance, NYC pension funds are leading the way for other investors to hold North American banks accountable on climate issues. 

“Given the climate emergency, [investors] can no longer delay action and should do everything in their power for these resolutions to be adopted,” she said. “But they must also recognise that asking for disclosure is not enough and should engage to ask for concrete climate action from banks, such as more financing for sustainable energy.” 

The practical information hub for asset owners looking to invest successfully and sustainably for the long term. As best practice evolves, we will share the news, insights and data to guide asset owners on their individual journey to ESG integration.

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