Phasing Out Fossil Fuel Finance: Challenges and Opportunities in the Banking Sector

A well-planned and executed phase-out of fossil fuel investments is essential to meet our climate goals. However, recent research published in Nature Communications highlights the systemic challenges involved. While some banks have withdrawn from fossil fuel financing, others have stepped in to fill the gap, continuing to support and expand fossil fuel projects globally. As of today, global investments in fossil fuels are still overpassing investments in clean energies.

The Paris Agreement goal of limiting global warming is clearly at risk without a rapid decline in fossil fuel use. As of September 2024, the Paris Agreement's goal of limiting global warming to well below 2°C, preferably 1.5°C, above pre-industrial levels is in jeopardy. Based on current policies and pledges, projections indicate a warming of around 2.5°C to 3°C by 2100….and we are still not going in the right direction. Banks are crucial in sustaining the fossil fuel industry through their lending practices, especially through syndicated loans where multiple banks pool resources.

In 2023, financing of fossil fuels by the 60 largest global banks decreased by 28% compared to 2022. However, while some key banks have shown progress in reducing lending, their efforts are being offset by increased lending from other regions, especially in Asia-Pacific. As one of the results, according to the International Energy Agency (IEA) , global coal production in 2023 reached a new all-time high of approximately 8.74 billion tonnes, marking a 1.8% increase compared to 2022. We will have to follow figures for 2024.

In fact, a complex system of syndicated lending allows for the substitution of finance between banks, potentially undermining phase-out efforts. We need to understand that individual banks' contribution to fossil fuel lending extends beyond their direct investments through participation in syndicated deals, where multiple banks pool resources. This allows for financing large projects and spreads risk. This principle of syndication drives significant financial support to the fossil fuel industry: Today, according to Nature Communications, syndicated loans are a major source of fossil fuel finance.

As capital markets price climate-related risks, bank loans may become even more crucial for fossil fuel firms. Syndication also creates lending networks, facilitating finance mobilization and reducing informational friction. This can lead to finance substitution, where finance phased out by banks in countries with stricter climate policies is replaced by foreign lenders, as seen in Australia's coal lending market recently.

As of 2021, the countries whose banks contribute significantly to fossil fuel financing are the USA, Canada, Japan, China, France, and the UK. Trends shouldn’t have changed drastically over last few years.

The substitution of finance between banks in syndicated deals hampers the phase-out of fossil fuel financing. Regulation should counteract this substitution, creating a tipping point where substitutable finance runs out. This tipping point's timing depends on regulatory stringency, with fewer banks needing to exit under stricter rules. Clearly, the phase-out would be more efficient when targeting large lenders, emphasising the need for strategic coordination. Regional regulation is also crucial, particularly concerning US, Japanese, and Canadian banks, due to their global interconnectedness. Chinese banks are an exception, as their isolation could lead to significant declines in financed fossil fuel deals. A timely and ordered phase-out necessitates regulatory fast action, potentially through capital requirement rules.