Excluding polluting clients ‘not the right approach’ for net-zero-focused banks

Banks can do more to smooth Europe’s transition to a net-zero economy by engaging with high-polluting clients than by refusing to lend to them, according to a senior figure in the German banking sector.

Many of Europe’s banks have signed up to the Net-Zero Banking Alliance, committing to bringing greenhouse gas emissions linked to their lending and investment portfolios to net-zero by 2050. Regulators such as the European Central Bank could force them to hold more capital to reflect the risk posed by their exposure to polluting sectors.

Banks are now considering if and how they should do business with high-polluting clients, said Torsten Jäger, director of sustainability at German bank association Bankenverband, at the European Banking Institute’s annual conference on Feb. 24.

“Exclusion is not the right approach,” said Jäger. “It would be easy to get rid of all the [polluting] assets on a bank’s balance sheet. But banks have more power and more impact if they retain their clients and engage with them.”

Influence on borrowers

Banks can have a huge influence on the net-zero transition through their data-collection capabilities and development of climate risk scores, Jäger said. The loan origination process is key and is where banks have the highest impact on their clients, he said.

The ECB will carry out a climate stress test in the first half of 2022 to assess how prepared banks are for dealing with financial and economic shocks stemming from climate risk, with aggregate results expected to be published in July.

Regulators must apply short-term horizons on climate risk, and not longer-term scenarios, when considering capital requirements for banks, according to Jäger.

“If you broaden the risk horizon, the [capital requirement] figures will be astronomical,” Jäger said. “Driving management action would be difficult and more capital won’t help if you don’t have a viable business model.”

Capital adjustment

Jäger suggested lowering the levels of capital that banks have to set aside to cover losses or provide creditor protection in the event of insolvency. This would free up funds and set an incentive to help fund the transition to net-zero.

“Prudential regulation has a role to play in fighting climate change,” Jäger said. “And prudential regulation should send a clear signal that sustainable loans and investments are in focus.”

Matthew Scott, a former Bank of England official and senior director of climate and resilience hub at insurance company Willis Towers Watson, said that this would be a “very risky step.”

“It could actually distort asset prices and create asset bubbles and takes away the purity of the risk mandate that central banks have,” Scott said.

Pushing the transition to net-zero economies should be addressed through governments’ fiscal policies and subsidies rather than “through the backdoor of the central banking policy,” Scott added. “Once you cross that [threshold], it’s a dangerous place to be.”


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