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There is increasing pressure on financial organisations to be more of an active part of the transition to a low-carbon world. Banks are now faced with the questions of how and what can they do to be a part of the solution to climate change, rather than contributing to the problem.
Why do financial institutions need to think about this?
The banking and finance industry plays a significant role in our changing climate. One area in which it can play a leading role is in lending decisions. In 2020 European companies covered close to 70 per cent of their financial needs through banks and bank financing was relevant for more than 50 per cent of SMEs*. As these businesses require financial services to function successfully, it might be seen as inevitable that stakeholders would look to the financial system to be a part of creating the tools and incentives aimed at changing behaviour of sectors responsible for emissions. By financing carbon-emitting activities, some banks are increasingly seen to be contributing to a unsustainable future.
What actions are banks already taking?
There are many international initiatives aiming to be a force for change (e.g.: United Nations Environment Programme (UNEP) Principles for Responsible Banking, Task Force on Climate-related Financial Disclosures (TCFD), etc.). But at the moment most banks are approaching climate change from a reactive approach, assessing and quantifying each loan decision and the resulting portfolio as a financial risk.
The expectation is that this will move the needle towards the right direction... but is this fast enough?
As established by former Governor of the Bank of England Mark Carney when thinking about the priorities for private finance for COP26, we need to ensure that ?every financial decision takes climate change into account?. In this sense, the banking and finance industry increasingly recognises the need to move to a purpose-driven approach which enable industry and individual-level actions.
Where to next?
Banks can no longer consider themselves agnostic intermediaries providing products for their clients - they need to use their knowledge to ensure clients are aware of the full set of options available.
This requires tough decisions about what types of funding to stop altogether (e.g. not funding coal) and where to actively broaden their offers to create and promote attractive, lower-carbon alternatives to meeting their clients? needs. It also means banks saying to their customers "did you know we could offer you this (attractive) loan package for a heat pump? Would you like to reconsider your request for a loan for a boiler?"
For this last objective, banks have the opportunity to leverage on behavioural data and the wider set of behavioural economics toolbox to observe and understand how and when their clients take decisions which could help or damage the climate.
*SAFE, Annual Survey on the Access to Finance of Enterprises 2020
Paula Papp, Associate Director, Frontier Economics