How banks can contribute to the Paris Agreement and the Sustainable Development Goals
Ben Caldecott, Director, Oxford Sustainable Finance Programme & Associate Professor, University of Oxford
The banking sector is where the financial system and the real economy meets. Banks provide loans and services critical to companies, households, and governments. The Sustainable Development Goals (SDGs) and the Paris Agreement are unattainable without banks financing solutions to these massive social and environmental challenges. Nor can we have efficient, fair, and resilient financial and economic systems if banks fail to manage and reduce environment-related risks, particularly climate-related risks, for themselves and for their clients.
In September 2018, the Bank of England published results from a survey of 90% of UK regulated banks representing over £11 trillion in global assets. The survey was designed to see how these banks view climate change. It found that while 70% of banks recognise that climate change poses financial risks, only 10% view climate change more holistically and take a long-term strategic view of the risks. Disappointingly, only 30% of banks still consider climate change as only a corporate social responsibility (CSR) issue, with little or no relevance to business strategy or operations.
The survey was interesting for a number of reasons. First, it highlighted how climate change has quickly gone from merely one CSR issue to a topic of concern for risk management, client relations, investor relations, product development, government affairs, and marketing, among other areas. In other words, it is now seen as increasingly relevant across a business and therefore needs to be managed in that way by senior executives and the board. It is worth remembering that few (if any) banks anywhere in the world would have viewed climate change as ‘strategic’ at the beginning of this decade.
Second, it highlighted how we still have a long way to go. How long will it take to go from 10% of banks viewing climate as strategic to 100% seeing it that way? And while viewing an issue as strategic is important, what does that actually mean in practice? How do we achieve a transition in how banks think about these issues and simultaneously achieve significant changes in practice too?
Third, while climate-related risks have risen up the agenda, there are a wider range of environment-related risks that are material and potentially of systemic importance, including risks related to nature and biodiversity loss. In April 2019, the Central Banks and Supervisors Network for Greening the Financial System (NGFS) highlighted how this is a gap where much more work needs to be done. The NGFS includes 36 central banks and supervisors – representing five continents, half of global greenhouse gas emissions, and the supervision of two thirds of the global systemically important banks and insurers.
Fourth, the focus has been on climate change as a risk, but there is growing demand from clients, policymakers, and other stakeholders to also examine the positive and negative impacts of loans and services provided by banks for meeting the Paris Agreement. How do we ensure individual banks and the entire banking sector are making loans aligned with climate change and the other SDGs?
This throws up a wide range of challenges and opportunities for banks and the banking sector. Here are some:
Clearly, the transition in thinking needs to accelerate, rapidly followed by systematic operationalisation across banks. Changes in norms, practices, and standards are changing and can change quickly. This is being supported by new qualifications, for example, new courses on sustainable finance by the Chartered Banker Institute and the CFA, as well as by efforts to mainstream these topics in existing qualifications and professional standards.
Regulatory change will also spur reform. In April 2019, the Bank of England published a new supervisory statement for UK regulated banks and insurers. This means that UK regulated entities must have comprehensive plans to manage the financial risks of climate change and designate responsible managers under the Senior Managers Regime. Regulated firms will need to submit plans and identify responsible individuals by 15th October 2019.
This change in regulation and supervisory practice is impressively comprehensive. It means that all UK regulated banks (and insurers) need to have capabilities and tools to measure and manage climate-related risks, including short and long-term scenario analysis. It means that banks will need to disclose these risks and have clear lines of responsibility for the management of such risks, including at the board level. It also sets out clearly that the stringency of supervision will ratchet over time as practices evolve.
This is a major development and one that I expect will be quickly replicated across jurisdictions represented in the NGFS.
Innovations in practice will also speed up the process. The data and analysis required to measure and then manage different environmental risks and impacts is changing. Earth observation and remote sensing combined with artificial intelligence will transform the availability of information in our financial system and change how risks, opportunities, and impacts are measured and managed by banks and financial institutions.
New products, such as Sustainability Improvement Loans, where clients receive lower interest rates if they meet or outperform sustainability measures, are a powerful incentive and can create business opportunities for banks, lower credit risk, and support the real economy transition.
Banks can also support retail clients, from high-net-worth individuals to the smallest millennial retail savers, and help them align their own assets with the need for much smaller environmental footprints. How banks can engage with retail clients and provide them with solutions is a big opportunity for winning business, as well as for accelerating systemic change. This extends from green mortgages, enabling energy efficiency retrofits, through to empowering individuals to engage constructively with the companies. These efforts can help normalise and mainstream behaviours necessary for tackling climate change.
The real economy cannot transition in time to meet the SDGs and the Paris Agreement without the banking sector providing the capital and services needed. It is in the interests of banks to move quickly given the scale of the opportunities and the risks that are already materialising. Banks need to develop comprehensive strategies, together with detailed plans for implementation tied to appropriate resourcing and levels of accountability to ensure implementation. This will likely become a mandatory regulatory requirement, and this is already so in the UK. But banks should be responsible and act sooner rather than later. Critically, it is also in their own commercial interests to do so and they should not wait for regulation.
Read the Sustainable Finance Report here.