Article
25 Oct 2021

Banking the Energy Transition

Global Insights
Contributor(s): Citi Global Insights
Bank lending has a vital role to play in the planet’s green energy transition. A new report from Citi’s Azzurra Guelfi, summarized here, looks at progress to date in Europe, how investors can screen banks on their climate efforts, and if new revenue opportunities are emerging.

Ahead of the UN Climate Change Conference (COP26, link), Citi Research’s analysis of climate targets shows that European banks are ramping up their efforts and, given the level of achievement so far, more ambitious targets could be presented.

European Banks – Average Achievement Ratio of Selected Climate Targets, By Country

European Banks – Average Achievement Ratio of Selected Climate Targets, By Year

Uploading image...

Source: Company data and Citi Research Estimates

Source: Company data and Citi Research Estimates

 

 

 

 

 

 

 

 

 

 

 

Banking sector emissions are coming down, in part due to the pandemic’s impact, but indirect emissions relating to loan books are key. The introduction of the EU Green Taxonomy and higher regulatory focus, for example in the form of climate stress tests, should improve disclosure and give investors better tools to screen banks on their climate efforts. Citi analysts identified asset quality and capital risks, but found there could be new revenue opportunities, too.

Banks can play an essential role in supporting the green transition via lending strategies and their own actions. Climate strategy and targets are becoming more and more a common discussion topic for bank executives, and with the market.

Most banks have Paris agreement adoption as target by 2050. Not many have opted for a 2030 target. Citi analysts reckon this could be one of the more ambitious targets to be presented.

French, Benelux, UK and Swiss banks generally have broader disclosure on the climate topic. Few banks provide details on the loan book indirect emission, and Citi analysts reckon that’s important data to disclose and monitor to assess the success of lending policies as well as support for climate transition in the broader economy. Some banks have focused also on biodiversity, but with no material quantitative indications.

Banks sector direct emissions are small compared to other sectors and decreasing (-c11% YoY in 2019 and -33% in 2020, also due to the pandemic effect). There is limited disclosure and comparability with indirect climate impact. 

European Banks – Evolution of Annual Emissions (Thousands of Tonnes of CO2 Equivalent)*

European Banks – Evolution of Annual Emissions, YoY (%)*

Uploading image...

Uploading image...

Source: Company data and Citi Research; * Scope 3 emissions don’t include emissions related to loan book / customer assets.

Source: Company data and Citi Research; * Scope 3 emissions don’t include emissions related to loan book / customer assets.

 

There is increased regulatory focus on banks’ climate risks, and regulators are generally working on establishing a framework to assess them, mainly linked with loan books and exposures.

Many regulators have started performing climate-related stress tests to increase focus on the importance of climate and future initiatives, and to inform regulators on system-wide policy issues.

The ECB recently published the results of its economy-wide climate stress-test, which included about 1,600 consolidated banks, data from about 4m companies, and covered a period of 30 years. The findings of the exercise indicate that without further climate policies, the most vulnerable 10% of banks may see a 30% increase in the average probability of default of their credit portfolios by 2050. The results will help inform the separate supervisory climate stress-test of individual banks that ECB Banking Supervision will carry out in 2022. There are no specific capital requirements related to climate risk, but Citi analysts expect this to become a key point of discussion going forward. 

As part of the stress-test exercise, the ECB analysed corporate exposure to physical and transition risks. According to the analysis, while European countries are similarly exposed to transition risk, there is significant variability in terms of exposure to physical risk. Firms exposed to high physical risk are predominantly concentrated in the south of Europe, for example Greece, Italy and Spain.

Climate policies, in addition to limiting the potential impact from reputational risk, are also a key tool to mitigate climate change and reduce potential asset quality risk derived from both physical and transitional risks on the loan book and assets, and could provide essential tools to monitor capital allocation and usage.

In addition to the asset quality/capital risks, the Citi report flags opportunities for new revenue streams to be originated by sustainable/green/social bonds as well as renewable financing and advisory for customers to manage the climate transition. Also, given the high level of data and interactions that banks have with customers and broader economic entities, they are well placed to provide advisory for ESG/climate migration/ratings, for both SMEs and large corporates.

CO2 Emissions Decreasing

On a comparison of greenhouse gas emissions by sector, the most polluting sectors are road transport, agriculture, iron and steel. The financial sector has a lower relative contribution to global emissions, relating only to emissions from the heating of company buildings, car fleets, use of electricity, and business travel (among others).

Direct emissions are low, and while a reduction is ongoing, banks’ indirect emissions (eg loan books) are significant, and ongoing inclusion of climate-friendly lending/financing policies could be a key factor in the success of decarbonisation for the planet. Only a few banks disclose some information on emissions related to their lending / financing activities, and it is likely that the market would appreciate broader disclosure.

Global Greenhouse Gas Emission by sector

European Banks – Evolution of Annual Emissions, YoY (%)*

Uploading image...

Source: Our World in Data

Source: Company data and Citi Research; * Scope 3 emissions don’t include emissions related to loan book / customer assets.

The role of banks will undoubtedly attract scrutiny for years to come. The question of whether their lending practices fit with their stated intentions around climate mitigation will become ever more central. All will feel pressure from investors and regulators to display greater transparency and granular detail on how their lending practices can help the drive to net zero. For more information on this subject, please see European Banks and Climate - Final Countdown to Net Zero Started

Citi Global Insights (CGI) is Citi’s premier non-independent thought leadership curation. It is not investment research; however, it may contain thematic content previously expressed in an Independent Research report. For the full CGI disclosure, click here.

Get in touch
If you need further assistance, Contact Us.

Why cookies on the Citi ICG website ?

This website uses cookies to give you the best user experience by personalizing your content and analyzing traffic. Without cookies, the site won't function as expected . If you want to learn more please read our Privacy policy.