If the world is going to achieve the lofty target of reaching net-zero emissions by 2050, one thing is clear: Banks need to take a leading role in financing the transition. 

Limiting warming to 2°C by 2050 will require $3 trillion annually in investment, according to an estimate by the Intergovernmental Panel on Climate Change. And that means annual investment in low-carbon energy technologies and energy efficiency needs to be increased by roughly a factor of five by 2050 compared to 2015 levels.

The importance of the banking industry’s role in achieving net-zero goals was underscored on April 21 when 43 banks from 23 countries with $28.5 trillion in assets joined the newly-created United Nations-backed Net-Zero Banking Alliance, part of the Glasgow Financial Alliance for Net Zero chaired by U.N. Special Envoy on Climate Action and Finance Mark Carney. 

Over recent months, we’ve seen major financial institutions up the ante by setting a host of net-zero commitments. In March, U.S. giant Wells Fargo & Co. announced a goal to achieve net-zero emissions by 2050, following hot on the heels of announcements from other major U.S. banks like Goldman Sachs and Citigroup. U.K. megabank HSBC made a similar move in 2020, while several lenders regarded as leaders in green finance such as France’s BNP Paribas extended already stringent coal exit policies.

S&P Global Market Intelligence data shows that the five largest U.S. public banks reduced their exposure to energy and utilities in 2020 compared to 2019. 

The picture was similar among some of the largest European banks. French giant Crédit Agricole, which has an aggressive climate policy, lowered its exposure, as did Deutsche Bank, Lloyds Banking Group and Barclays, which announced a new climate policy in early 2020 following pressure from shareholders. 

However, in the Asia-Pacific region, banks are lagging their European and U.S. peers. Bank of China, Japan Post Bank and Industrial & Commercial Bank of China reported increased exposure to energy and utilities, while Agricultural Bank of China and China Construction Bank Corp. decreased their exposure.

Regulators, policymakers, investors and much of the public are heaping pressure on banks to reduce their exposure to polluting industries such as coal or oil and gas for fear of stranded assets over the long term. 

Banks need to take climate change seriously — their exposure to the wider economy through lending portfolios across industries means that they could be at a higher risk than other sectors. Banks have relatively low Scope 1 emissions — those are emissions from their direct operations — but higher Scope 3 indirect emissions financed through their loans and investments.

Increased climate-related natural disasters such as wildfires or hurricanes may ultimately inflict losses on banks through asset fire sales, falling real estate values, weakening of corporate and household balance sheets and declining output in affected areas. 

That risk is only growing. In 2020 the U.S. broke an unsettling record, experiencing 22 extreme weather and climate change-linked disasters that each cost in excess of $1 billion, according to figures recently published by the National Oceanic and Atmospheric Administration. Those events collectively caused at least $95 billion in damages, killed at least 262 people and injured scores more. Prior to 2020, the largest number of annual major disasters was 16. To put the threat in context, almost 60% of the companies in the S&P 500 have at least one asset at high risk of physical climate change impacts, according to S&P Global Sustainable1.  

Setting a target is ‘the easy part’

Without banks, the move to net zero just won’t be possible. 

“That is one of the most important things about these net-zero goals: If banks are not moving, if they are continuing to fund high-carbon, high-risk industries, then the industries themselves won’t change,” said Danielle Fugere, president of nonprofit organization As You Sow, which has been behind a number of shareholder resolutions on climate policy at major lenders such as JPMorgan Chase & Co. 

“As long as there is money out there to do the wrong thing, the wrong thing will happen. Banks are critical to moving capital to a low carbon economy,” she said in an interview. 

But lenders acknowledge that turning their net-zero commitments into concrete action will be a challenge. 

“If I am honest, making the commitment is the easy part,” said Amit Puri, global head of environmental and social risk management at Standard Chartered Bank, which is headquartered in the U.K. but derives most of its profits in Asia, the Middle East and Africa.  “The work really begins now and our approach is both top down and bottom up.” 

The bank has committed to achieve net-zero emissions from its financing by 2050. Science-based scenarios mean the bank would need to reduce emissions by 50% by 2030, well beyond usual business cycles, he said.

“We are really trying to figure out on a sector-by-sector basis, on a geography basis, where are we today, where is the baseline, and therefore what do we need to do to reduce emissions in line with  [our] commitment?” Puri said in an interview. “It is throwing up whole series of questions that we are trying to figure out. Should we write new carbon-intensive business? Which methodology should we use?” 

The opportunity in net zero

While climate change poses clear risks to the financial sector, a move to net zero also presents opportunities for banks: to finance technology and growing sectors such as renewable energy, to issue sustainable debt, and to underwrite new types of mortgages and loans based on a companies' sustainability performance.

Green finance has grown exponentially in the last few years, and appears poised to continue expanding. For example, green bonds — debt that finances environmentally friendly projects such as wind farms or solar power — have grown rapidly over the last eight years, from virtually nothing in 2012 to $282.05 billion in 2020, based on figures from the nonprofit Climate Bonds Initiative, which promotes green investment. But that figure remains a tiny fraction of the debt market and won’t be enough to deliver the net-zero goals of countries, corporations and financial institutions.

The market could be poised for expansion in other kinds of sustainable debt as well. Issuance of social bonds — debt instruments that finance social projects, including affordable housing, health and education — blossomed in 2020 to reach $162.34 billion, up from $17.81 billion in 2019. Sustainability bonds also enjoyed a surge, with issuance rising to $136.40 billion, up from $40.99 billion, according to an International Capital Market Association analysis of the Environmental Finance database. Sustainability bonds are a hybrid of green and social bonds.

Tough love

Not every client will make the transition rapidly enough, and that means some banks will face difficult business decisions. Laurence Pessez, head of corporate social responsibility, told S&P Global last year that the bank expects to lose up to 50% of clients in power generation because of its commitment to stop financing coal. 

And that’s a fact that other lenders will have to confront, too. 

As You Sow’s Fugere called this “the sticking point.” 

“Every single bank we speak with says ‘we’re not going to turn our clients away, we’re going to help them move.’ And in the end, you can help them but they are going to have make some hard choices,” she said. 

“There will be companies that are not transitioning, that are not doing it fast enough so that is where the rubber is going to meet the road how and when do they stop funding the worst greenhouse gas emitters?”