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Many financial institutions have pledged to minimise their exposure to climate transition risks. But moving assets away from sectors with high emissions is sometimes at odds with supporting climate transition investments, as sectors with high emissions – such as utilities and transportation – require capital to invest in greener technologies. This column analyses the tension between reducing climate transition exposure and realising green transition goals. The authors find little evidence that banks are moving assets out of high-emission sectors, which is bad news for risk management but good news for climate finance.
Climate transition risks can arise from mitigation policies such as those related to carbon pricing, advancements in green technologies, or rapid shifts in consumer preferences. In all cases, demand shifting away from fossil fuel-dependent firms and industries may result in a rapid drop in the value of such assets, putting the asset values of financial institutions exposed to these firms and industries at risk. Financial institutions can reduce their exposure to climate transition risks by divesting from such assets or by investing in climate-friendly assets that will rise in value with the climate transition, providing a hedge against transition risks (Yang and Yasuda 2023). Opportunities for the latter option are relatively limited (Ameli et al. 2021), which means that any shifts in assets away from fossil fuel-dependent industries are likely to be towards industries unrelated to climate considerations rather than towards enhancing investments in climate solutions. This pattern reduces the transition risk exposure of financial firms but also raises the cost of capital for sectors that need financing to green their technologies (Hartzmark and Shue 2022).
Starting in 2006, many financial institutions, including banks, embraced their role in meeting sustainable development goals by creating a coalition following Principles of Responsible Investments (PRI). Among these principles, climate sustainability is one important goal. In 2015, financial regulators started to include climate-related risks in their discussions of financial stability, which led to the establishment of the Task Force on Climate-Related Financial Disclosure (TCFD) by the Financial Stability Board. In 2017, the Network for Greening Financial System (NGFS) was launched by a coalition of a handful of central banks aiming to encourage banks to properly price their climate risks. Finally, in 2019, the Principles for Responsible Banking (PRB) were launched with the idea that by accounting for climate-related risks, financial institutions would move money away from high-emission sectors, thereby ‘greening’ their portfolios and disincentivising investment into technologies with high emissions. Many banks have subscribed to the PRI, TCFD, or PRB agreements, all of which require some degree of measuring and disclosing greenhouse gas (GHG) emissions embedded in the assets of financial institutions, as well as limits to such exposure.
Have these efforts led to substantial divestment of financial institutions from highly emitting sectors, which would typically require funds for green investments? Our recent paper (Hale et al. 2024) evaluates the exposure of the 64 largest global banks’ syndicated loan portfolios (including their affiliates) to highly emitting sectors worldwide. These banks differ substantially in their climate commitments through the aforementioned initiatives, which allows us to identify the impact of these efforts on banks’ loan portfolios.
While there is some trend towards lower exposure to highly emitting sectors, we find no significant difference in the adjustments to their portfolio of assets between the banks that made explicit climate commitments and those that did not. This can be seen even in raw data (Figure 1). In the paper, we formally analyse whether banks that subscribed to any of the three agreements changed their investment portfolio in ways that differ from those that did not. We also consider an event study in which we look at the emission-related composition of syndicated loans originated by banks in the years immediately following their signing of PRI, TCFD, or PRB compared to the banks that did not sign in these years. Our results confirm the raw evidence from Figure 1: we find no discernible differences between the country-industry composition of syndicated loan origination portfolios across banks that can be attributed to their climate commitments. Our findings are consistent with a number of studies including Rickman et al. (2024) for the syndicated loan market, as well as studies focusing on the loan portfolios in their entirety (Bruno and Lombini 2023, Gianetti et al. 2024, Sastry et al. 2024).
Figure 1 Density plot of emissions by signatory status and year
a) TCFD
b) PRB
c) PRI
We also analyse whether there were changes to loans’ maturities, since shorter-maturity loans reduce transition risk exposure (although they are less useful for funding green transitions). We do find some evidence that banks which signed PRI temporarily reduced maturity of the loans to highly emitting sectors extended within four years of signing. In the year of signing the PRI, loans a signatory bank extended to highly emitting sectors have an eight-month shorter average maturity than that of a loan extended by the same bank to a median firm in the same year. This effect gradually disappears over time and is no longer present five years after signing. We do not find the same effects for TCFD or PRB signatories.
What should we take from these findings? Our results suggest that the efforts to reduce banks’ exposure to transition risks gained no more traction than the trend already in place at the time. We note, however, that our analysis focuses on potential exposure changes across sectors and not across firms within sectors. When focusing on particular sectors, the literature has provided some evidence that financial institutions reduced their exposure to the coal sector (Green and Vallee 2022), and that some banks charge elevated loan rates to highly emitting firms in the EU following COP21 (Altavilla et al. 2023). Given the limited information on firm-level emissions, our data cannot tell with certainty whether banks shifted their loans within highly emitting sectors towards greener firms. To answer such questions, we will have to wait for emission disclosure regulations to take full effect. At this stage, we cannot point to any substantial reduction in banks’ exposure to transition risks. From a financial risk perspective, this conclusion can be seen as bad news. On the other hand, it may mean that syndicated loans, which are key to financing large capital investments, are not moving out of the sectors that need such capital investments to research and implement greener technologies, such as the utilities and transportation sectors.
Source: cepr.org
