Regulation is not the way to hold banks to account over climate change risk, and they will shift assets out of polluting industries voluntarily, according to the global head of sustainability at Spain's largest lender, Banco Santander SA.
Federico Gómez told S&P Global Market Intelligence that banks would always aim to be one step ahead of regulators in tackling risks to their balance sheets.
Federico Gómez, global head of sustainability at Banco Santander.
"I don't think we need to be forced by regulators to do the right thing, because we believe it is the only way to have profits [and] be successful in business," he said.
Sustainability is the only route to success in the long run, he said.
The financial sector is coming under increasing pressure from regulators, who are concerned that banks could be left with stranded, or worthless, assets because certain industries they finance may become obsolete.
To address such questions, the sector itself is undertaking measures to make its business more sustainable.
Banks are increasingly financing renewable energy projects, and Santander ranks among the top 10 European issuers of green bonds. In 2018, the bank underwrote €730 million in green bond issues and €2 billion in syndicated loans based on environmental, social and governance criteria.
In September the United Nations Environment Programme Finance Initiative will launch the Principles for Responsible Banking. Santander is one of the founding members, along with other major European lenders including Banco Bilbao Vizcaya Argentaria SA, Société Générale SA and BNP Paribas SA.
With the principles, banks will be able to measure how they are contributing to the goals of the Paris Agreement on climate change, which aims to limit global warming ideally to 1.5 degrees C above pre-industrial levels, and to 2 degrees C more at the most.
The guidelines will encourage banks to disclose more information on how they are financing the low-carbon economy, Gómez said.
The European banking sector has been lobbying for a "green supporting factor," or lower capital requirements for financing sustainable projects such as solar power or wind farms, and the European Commission has been exploring the idea under its sustainable finance action plan announced March 2018.
Gómez suggested that a "brown penalizing factor" should also be considered. This would see banks having to carry more capital to cover investments or lending in polluting sectors.
He said there is little data to support the idea that a "green" investment is any less risky than a "brown" asset, which includes investment in the coal industry, and that the sector needs the correct definition of what green assets are and how risky they are compared with brown ones.
Need for data
Part of the EU's sustainable finance plan is the creation of a classification system, or taxonomy, to define what a sustainable asset is, which Gómez said would be key in deciding on whether to implement lower capital requirements for banks.
"Then we will have empirical evidence, a methodology and valuation of this risk and in the long run we can think about a green supporting factor," he said.
The lack of forward-looking data to help banks calculate their long-term climate change risks is a major challenge. Knowledge of how to transition assets is limited, so banks need more information in order to adhere to international frameworks such as the G-20's Task Force on Climate-related Financial Disclosures.
Santander is analyzing internally the best way of managing climate risk going forward, Gómez said. Banks often take a sector-by-sector approach to the financial risk of climate change, and Santander's approach depends very much on a company's size and business.
Taking an individual approach to SMEs is impossible because detailed information is not necessarily available, the executive said. Santander looks at its portfolio holistically, analyzing sector by sector and making a deep dive in those that are more exposed to climate change like oil and gas, he said.
Large companies have more information publicly available, so the bank is able to analyze the risks on an individual basis, and also look at the risks within a specific sector, he added.
In December 2018 Santander, whose business spans Latin America, the U.K. and Poland, announced it would no longer directly finance coal mining or coal-powered plants.
But it has come under fire from environmental groups for continuing to finance Poland's largest power company PGE Polska Grupa Energetyczna SA. They say Santander and other banks should exit coal funding immediately. France's BNP Paribas has said it will no longer finance electricity producers in Poland because of their coal dependence.
But Gómez said it was much too complicated to simply walk away from coal.
"What we need to do in Poland is to help our clients in the transition to a low-carbon economy in an orderly manner," he said. Exiting coal in one fell swoop would have huge financial and social implications, especially as 75% to 80% of the Polish power sector is based on coal, he said.