OIC banks can improve their climate impact by learning from the challenges of global banks

The pace of announcements of responsible finance targets—especially about climate—has continued to grow. Concerns about greenwashing have been consistent and have begun to be incorporated into regulation. This pressure from stakeholders, including regulators, has contributed to a reduction in the easiest forms to identify. An analysis by RepRisk has found that, by their metric, greenwashing risk for companies has fallen for the first time since 2019.

Greenwashing includes companies producing convincing but misleading statistics, targets or descriptions to describe their environmental impacts. One place where the greenwashing risk is likely to be easiest to hide is in financial institutions’ targets around climate mitigation and the Just Transition. Because climate change is a problem of collective action, it can be easy to shift blame because no single country, company or financial institution can solve the problem.

Financial institutions that have set or announced targets, and are working on the process of baselining their current emissions, will have to prioritize where they put their focus. A recent update by the Transition Pathways Initiative (TPI) on progress on transition in the banking system has provided useful insights.

The report focuses on banks with a longer track record of target setting, measurement and transition planning and should be interpreted accordingly for the purposes of OIC-based financial institutions and those in Islamic finance. One challenge the larger banks face is that their climate targets and decarbonization pathways are often too narrowly targeted for one or a few sectors.

The way that banks approach target setting is often focused on high direct emitters like banking for the oil & gas and electricity generation sectors. These are often clearly material, especially for global banks, but national or regional banks that operate in most OIC markets may have different sectors that carry the most relevance.

The determination of materiality that banks use to determine relevance is often geared around emissions and credit exposure in the banking book. The TPI specifically called out the lack of disclosures related to capital market activities (e.g., underwriting fixed income or equity issuance) as well as opacity about the materiality of different sectors from a revenue perspective.

Even for the largest banks, this has been an issue, TPI summarizes:

“Of the banks providing sufficient information, we estimate that targets cover on average only 22% of their total revenue. Only seven banks include capital market activities in their sectoral targets, meaning that significant portions of banks’ businesses are not covered.”

One of the challenges that banks often face when thinking about implementing policies on decarbonization targets is that it is conceptually easier to evaluate responsibility for financed emissions from the financing provided to high-emission companies. If a company has $1 billion of equity and $200 million of bank financing, and directly emits 1.2 MtCO2e per year, then a bank that provided $50 million of that financing would have financed emissions of 50,000 tCO2..

However, the same methodologies are more difficult to apply if the bank is involved as just one member underwriting a quarter of a $200 million debt or equity underwriting that is subscribed by other investors. Rather than providing financing directly, where it can more readily link its financing activity to future emissions, capital markets activity facilitates other investors who would be expected to account for the financed emissions.

But the investment bank could have applied the same effort to place equity or debt for lower-emission companies, or for companies promoting climate solutions. The methodologies for accounting and reporting these data are not as well developed, which leads to gaps in the data that are reported and what targets are set.

Similarly, a financial institution may report financed emissions only including its customer’s direct emissions and emissions related to their electricity use. This is the approach of the GHG Protocol, but it omits a company’s value chain and implicitly favours companies that are not vertically integrated (where more emissions would be counted as direct (Scope 1) emissions.) Decisions about corporate structure, or which entity in a wider group receives financing, can impact the financed emissions that are produced, even if the real-world emissions are not affected.

The lesson in these discussions about technical points related to financed or facilitated emissions is that disclosure alone isn’t going to provide an antidote to future concerns about greenwashing. Even a precise, accurate and validated measurement and reporting of a subset of financed emissions could omit enough that it becomes misleading when viewed in relation to the bank’s entire range of activities.

The point for banks to take away in planning their implementation is to not be too reliant on a single metric in their approach to decarbonizing their portfolios or rely on one measurement framework – even if prescribed in regulation – for understanding their climate exposure. The point is not just to disclose or set targets, but to take actions that produce real economy changes.

For example, a disclosure regulation could set the expectation for financed emissions reporting based on the GHG protocol. Calculating the relevant emissions in line with the regulation could highlight a specific set of activities that the bank should focus on in its decarbonization efforts. Yet, if a broader metric like PCAF were applied, this might highlight a different set of priorities based on including value chain emissions and facilitated emissions.

Other metrics have been proposed and supported, including a focus on financing extended for capital expenditures, which will influence longer-term (future) emissions trends. In this vein, Reclaim Finance has released a report that discusses in more detail the issues with bank decarbonization target-setting to date. Reclaim Finance along with the Institute of International Finance has also highlighted the Energy Supply Financing Ratio (ESF) as a useful metric.

The ESF compares the ratio of a financial institution’s exposure to fossil fuel-generated electricity to renewable energy financing. It is based on a finding from the International Energy Agency (IEA) that by 2030 there will need to be $6 of financing for every $1 of fossil fuel investment. Most banks are far from that target but can show progress by shifting the ratio in ways that are harder to exaggerate than other metrics sensitive to portfolio composition.

At the end of the day, the progress that matters is the decarbonization of the economy in a way that will increase the likelihood of staying under 1.5? C of warming while promoting a Just Transition away from current emissions sources. Showing progress on a single metric, or having one type of data calculated in the most precise way possible, won’t cover up for failure to have a real-world impact.

Investors and other stakeholders are already on the lookout for cherry-picked data, and it is critical for banks to challenge the data they are reporting or will be required to report when it comes to actually making decisions. The required types of data for disclosure can be useful, but always need to be challenged in the context of a bank’s operations and the economy in which it operates to ensure that another view of a bank’s actions won’t produce cries of ‘greenwashing’.

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