Navigating the Green Asset Ratio (GAR): A deep dive into banking’s new misleading sustainability metric

Understanding the GAR

In recently published sustainability reports, banks have been required to disclose their GAR for the first time. The taxonomy-alignment ratio is a key performance indicator (KPI) derived from the EU Taxonomy regulatory framework which originates from the EU Green Deal.

At its core, the GAR quantifies the proportion of a bank's assets that can be classified as environmentally sustainable in relation to its total covered assets. A simplified calculation is illustrated in the following figure:

The EU requirement for banks to publish the GAR is intended to trigger sustainable investment activities and to create an incentive for banks to fulfil their role as financiers of the green transformation.

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Why comparing the GAR of different banks is misleading

When calculating the GAR, only a specific subset of a bank's total assets, referred to as covered assets, can be considered. It is important to note that the assets included in the numerator and denominator differ, making it unlikely for any bank to achieve a GAR of 100%. Furthermore, within the covered assets, only a portion qualifies as taxonomy-eligible, meaning they can be allocated to one of the six environmental objectives. Among these taxonomy-eligible assets, only a fraction meets the EU Taxonomy sustainability requirements and can then be classified as taxonomy-aligned.

The subsequent figure illustrates the process of extracting the taxonomy-aligned assets from the total assets of a bank.

When taking a closer look at the taxonomy-eligibility ratios alongside the corresponding GARs of multiple national and international banks (see figure below), several issues become apparent.

It is remarkable that the average taxonomy-eligibility ratio stands at a low 24.7%, and the average GAR at a low 1.5%. This translates into an eligibility to alignment conversion rate of just 6,0%.[1]

The partially significant differences in taxonomy-eligibility ratios can be attributed to the varying business models of banks. Financing activities can only be considered taxonomy-eligible if their use of proceeds is known and can be allocated to one of the six environmental objectives of the EU Taxonomy.

However, for the low conversion rate of taxonomy-eligible to taxonomy-aligned assets, there are several reasons. The most decisive factor regarding corporate clients is that financing activities of a bank can only be taxonomy-aligned if the corporate clients themselves fall within the scope of CSRD. With respect to the different target groups of banks (large caps versus SMEs), there can be considerable differences and advantages considering the GAR. But even if a bank has substantial exposure to CSRD-relevant corporates, numerous data points are required to prove the substantial contribution of a financing activity to one of the six environmental objectives and the alignment with the science-based taxonomy criteria. At present, banks typically lack required data of sufficient quality.

Another aspect contributing to variations in the financing activities declared as taxonomy-aligned are inconsistencies in auditors' evaluation methods. Insights into several banks and projects revealed that different types of evidence are accepted as proof for sustainability of a financing activity. For example, some auditors accept synthetic energy certificates as evidence for taxonomy-alignment of private mortgage loans while others reject them.

Altogether, these factors and observations cast doubt on the metric's reliability and comparability.

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Which assets drive the GAR depends on a bank's data warehouse

The modest conversion rate from taxonomy-eligibility to alignment is just one notable aspect in comparative analyses of banks. Examining portfolio-specific conversion rates (as depicted in the figures below) reveals insights into the factors influencing GAR drivers:

A substantial volume of taxonomy-eligible financing originates from private households as private mortgage loans have a distinct use of proceeds. Consequently, transactions with private households have the potential to be the primary driver of the GAR. However, the private household financing’s conversion rate from eligible to aligned is comparably low. The main challenge with respective loans is meeting the criteria for taxonomy-alignment due to limited availability of certified energy certificates that auditors typically require.

Among the financial institutions benchmarked, ING shows a comparatively high conversion rate. This can be attributed to its extensive mortgage portfolio in the Netherlands. Unlike Germany, the Netherlands has more rigorous requirements for issuing official energy certificates, enabling ING to assess and classify a greater number of private mortgage loans as taxonomy-aligned.

Besides the difficulty of obtaining certified energy certificates, the EU Taxonomy’s requirement for information on the companies that have built or renovated the properties poses another challenge. For taxonomy-alignment of financings, banks must provide evidence that the craft companies involved adhere to minimum social safeguards, such as the International Bill of Human Rights and the basic principles of the International Labor Organization. It is apparent that ordinary craft businesses being compliant with these standards in unrealistic.

Compared to the financing of private households, a higher conversion rate to taxonomy-alignment can be achieved from the relatively small volume of taxonomy-eligible financing with non-financial companies. This is mainly because transactions with these counterparties can be classified as taxonomy-aligned on a pro rata basis, using the taxonomy KPIs reported by the respective corporation, even without a specific use of proceeds. As the scope of companies subject to the CSRD expands in the coming years, the volume of taxonomy-eligible and aligned financing with non-financial companies is expected to increase, thereby enhancing the contribution to the GAR in the long term.

And finally, achieving taxonomy-alignment for financing of financial companies is rare for two reasons. First, financial companies were not obliged to report taxonomy-alignment figures in 2022 so there is no possibility to assess exposures on a pro rata basis. Second, it is not common for two financial institutions to provide loans with a use of proceeds that is reflected by the EU Taxonomy.

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The current unsuitability of GAR as a sustainability indicator

The observations above illustrate the multitude of factors influencing the GAR, many of which are beyond the control of banks and may distort their actual sustainability efforts. This sentiment is also mentioned by several industry leaders such as Heiner Herkenhoff, Executive Director of the German Banking Association, who states, "The GAR does not adequately reflect the sustainability profiles of banks," thus concluding that "The Green Asset Ratio is unsuitable as a performance indicator for the transformation."[2] Andreas Gruber, Head of Sustainability at DKB, highlighted the GAR's incentivization problem as early as 2022: "Banks have no additional incentive to invest in renewable energies as a result of this taxonomy."[3]

The consensus appears to be that, although the GAR requires significant effort to determine, it does not create an incentive for banks to accelerate in becoming the financier of the green transformation.

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Need for action by regulatory bodies, banks, and corporates

There is a strong call to action for regulatory bodies, banks, and corporates when it comes to the GAR. They need to rework the concept of the GAR, ensuring that the real sustainability efforts of corporates are being reflected by the KPI. Banks must refine data collection (and storage) processes, especially in their front offices, to be able to respond to regulatory requirements. Corporates must work more closely with financial institutions and, in return for a green premium, provide the required data and facilitate the entire process.

The current regulatory system is flawed and renders the GAR ineffective. The need for action became obvious and regulatory bodies will respond accordingly. Agility in response to regulatory changes will be a key determinant of success in the sustainable finance landscape.

During these times of uncertainty, consulting services like Capgemini Invent become indispensable partners for financial institutions, helping them meet regulatory requirements through efficient data procurement and process optimization. Our expertise in navigating the complex interplay of regulatory expectations and operational capabilities makes us a valuable ally for any financial institution striving towards sustainability goals.

[1] All facts and figures are based on the turnover KPI and extracted from the annual reports of the respective bank

[2] Press release of bankenverband (Herkenhoff: Aussagekraft der Green Asset Ratio begrenzt (bankenverband.de), Bankenverband kritisiert M?ngel bei neuer ?grüner“ Taxonomie in der EU (handelsblatt.com))

[3] Photovoltaik- und Windparks sind keine Green Assets – pv magazine Deutschland (pv-magazine.de)