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Banks’ climate pledges don’t add up to change, research finds

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Like many other large institutions, banks have stepped up their pace in making voluntary commitments to combat climate change in recent years.

Most prominently, more than 138 banks, representing over 40% of global banking assets, have made commitments through the UN-convened Net Zero Banking Alliance. Their pledge: to “align lending and investment portfolios with net-zero emissions by 2050,” with intermediate targets for 2030 or sooner.

But are these types of voluntary climate commitments to accelerate decarbonization and scale up sustainable finance truly shifting the ways in which banks operate?

A new paper, “Business as Usual: Bank Net Zero Commitments, Lending, and Engagement,” suggests that the commitments aren’t having much of an impact.

“These voluntary commitments, on their own, seem to not be having the effects that perhaps people are hoping they might have,” said MIT Sloan finance professor one of the paper’s co-authors. “There’s been more talk than action.”

Specifically, Verner and co-authors Parinitha Sastry from Columbia University and David Marques-Ibanez from the European Central Bank found that net-zero banks haven’t divested from polluting sectors, haven’t scaled up project financing for renewable power projects, and have failed to influence climate behavior in the firms they lend to.

The results are concerning because many policymakers, activists, and other stakeholders believe that the private sector needs to play a major role in transitioning the economy away from carbon-intensive production. “Banks play a central role in capital allocation, so they are key to financing the green transition,” the authors note in their paper.

Divesting and influencing to meet climate commitments

To arrive at their findings, the researchers used data from the European Central Bank covering more than 300 banks from 2018 to 2023.

Around 10% of those banks had joined the NZBA, the largest and most stringent climate-related banking initiative. NZBA-aligned banks are required to set net-zero emissions-related targets for credit and investment portfolios, with a 2050 achievement date and milestones along the way.

The researchers compared the portfolios of the non-NZBA banks with those of banks that had joined NBZA. They detailed two ways by which institutions can meet their NZBA climate commitments and made key discoveries about those approaches.

Divestment. Banks can divest from polluting firms and then reallocate that capital to less emissions-intensive firms.

But Verner and his colleagues found no evidence that the climate-aligned banks were divesting from sectors on which they pledged to focus their emission-reducing efforts, including power generation, transportation, and oil and gas.

In fact, NZBA financial institutions were 3% more likely to enter into new relationships with firms in high-emissions targeted sectors than were non-NZBA banks.

Engagement. Net-zero banks can continue to lend to polluting firms but engage with them by pushing them to reduce their emissions.

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While the researchers found that climate-aligned banks loaned less money to firms in high-emissions targeted sectors, the amounts they loaned weren’t significantly less than loans made by banks with no voluntary climate commitment.

The climate-aligned banks the researchers studied also didn’t charge higher interest rates to high-emissions firms — or lower rates to “green” firms — and their borrowers, in turn, weren’t more likely to set their own decarbonization targets.

At the same time, the researchers discovered that NZBA-aligned banks did gain a major benefit from their participation in the initiative: Their ESG rating, as measured by Morgan Stanley Capital International, rose by 0.6 points on average in the two years after they made their climate commitments, which the authors characterized as “a substantial upgrade.”

Overall, the results call into question the effectiveness of voluntary climate commitments, Verner said. “It seems like there have been substantial commitments that have not really translated into meaningful changes in these banks’ business models.”

Government policy could help drive behavior

Despite the somewhat disappointing findings, there is still hope that voluntary climate commitments may end up making a real impact, Verner said.

With initial net-zero targets currently several years away, financial institutions do have time to reverse course and make progress. “We know from other circumstances that banks can change their lending very quickly,” he said.

To do so, banks need more data plus additional disclosure. Financial institutions could potentially make better-informed climate-friendly lending decisions if they had more information on their borrowers’ emissions.

Banks might also be able to structure loan contracts in ways that could incentivize borrowers to become greener. Influencing borrower behavior in ways like this is key, Verner said.

“This notion of divestment will only get us so far,” he said, “because other lenders can just step in, and you can’t destroy complete industries by not lending to them. Helping industries to become greener is important.”

Another way to encourage climate-committed banks to increase divestment and exert more influence over their borrowers could be to associate a cost with not making progress toward fulfilling the climate pledges they’ve made.

Damage to banks’ reputations might be enough to drive change. “But it’s difficult to credibly score how banks are doing,” Verner said. “Currently, banks can almost write their own report cards. Maybe we need government policy to drive behavior.”

Read next: Companies that submit to an audit see their emissions rise. And that’s OK

For more info Tracy Mayor Senior Associate Director, Editorial (617) 253-0065