Fossil Fuel Financing Still Going Strong

Happy net-zero sounds from banks don’t reflect reality.

Photo by Jp Valery on Unsplash

A new report by the European Central Bank (ECB), finds that a “staggering 90%” of European banks have loan books misaligned with global climate goals and the EU’s 2050 climate neutrality target.

Although 72 of the 95 banks in the study have made a net zero commitment, 93% of these are not yet aligned with a pathway to achieve the Paris Agreement goal of limiting climate change to 1.5C.

All talk, no walk.

The study focused on 6 carbon-intensive sectors in the EU including power, automotive, oil and gas, steel, coal, and cement. Globally, these sectors are responsible for about 70% of emissions.

The results weren't great. Out of 95 banks included in the study, only 8 had lending practices in line with the 2050 net zero path.

This latest report follows on a 2023 report from the European Central Bank; an examination of net-zero commitments by the world’s largest systemically important banks (G-SIBs). This 2023 study showed that 25 of these 30 G-SIBs have made public net-zero commitments. The report found that while most of the largest systemically important banks had made some kind of net zero promise, data was often scarce, not comparable, and any description of emission reduction targets tended to be rather vague.

Highlights of the 2024 report.

Here are a few choice words from the 2024 report with my translation below.

Based on forward-looking production data for assets within the sectors most impacted by the shift towards a low-carbon economy, this report assesses the risk stemming from the (mis)alignment of banks’ financing with EU policy objectives.

Translation - banking policy does not align with European sustainability or environmental policies. This isn't surprising. Banks are trying to make money and the incentives to move more swiftly to a low-carbon economy aren't sweet enough to make bankers value long-term environmental interests over short-term shareholder interests.

The euro area banking sector shows substantial misalignment and may therefore be subject to increased transition risks, and around 70% of banks are also subject to elevated reputational and litigation risk.

Translation - this misalignment with European policy puts banks more subject to transition risk. In future years as companies fail due to their inability to adjust to a lower carbon economy the banks that have financed them may begin to fail as well. The banks are in a bit of a dilemma. They must make happy noises about decarbonization to make regulators happy and to make society happy. But to make their shareholders happy, they must provide returns, and those returns mean lending to anyone and everyone unless they are legally forbidden to do so.

That means banks are going to lend where and when they can, including industries that aren't moving fast enough and the transition to a low-carbon economy. This points out one of the flaws and trying to make finance the method by which we move to a greener economy. Regulators and politicians don't want to be the ones who tell people they have to change, because that's hard. They are hoping that policy and regulatory tweaks around the edges can incentivize the banks and investors to do this for them.

Well, it hasn't happened that way. It is going to take some courage and the risk of not being elected again to tell people the truth and tell people that we need a faster transition. It will also require the sticks and carrots necessary to get banks, industry, and investors to play a bigger role in such a transition. These banks aren't evil. They are following incentives and acting in their shareholder’s best interests. Don’t hate the player, hate the game.

Now, I would argue for a more long-term view from these banks, but I understand them trying to do as little as possible under the current circumstances. I do not approve of their inaction. I am simply not surprised by it. Regulators and policymakers need bigger sticks.

A more in-depth analysis reveals the underlying factors contributing to the elevated transition risk in credit portfolios, which largely stems from financing counterparties that are either too slow to phase out their high-carbon production capacities or too slow to build out their renewable energy production capacity.

Translation – Check out the below chart from the report. You can see very few banks above that 0% line meaning only a handful of them are aligned with the Paris climate commitment. The report doesn't name them, but who were those poor banks way out on the right-hand side with such high exposure and that back way at the bottom with 0% commitment alignment with the Paris commitment? If I'm an investor that invests in European banks, I'm spending some time deciphering who those outliers are to make sure I'm not invested in them.

Incentives

I know these are all big, complicated problems, but the people behind them are just simple animals like the rest of us. Like any animal on Earth, we do what we are incentivized to do. Our incentive structures also rule bankers at big important banks in Europe. These bankers are incentivized to prioritize investor returns in the short term over our survival as a society over the long term.

That sounds quite a bit insane to me and to many people, put that to the system we have.

That's where we are. To change that will take wisdom and courage that is often in short supply until something breaks in a big way. There's a saying some of you might have heard that I think sums up this problem and it goes something like this:

Tough times create strong leaders.

Strong leaders create easy times.

Easy times create weak leaders.

Weak leaders create tough times.

Then the cycle continues.

We've had it very good for very long and those easy times have not created the strongest leadership among our political, business, or investor elites. People can tell you tough times are coming all they want, but it seems that we won't do much about it until the really tough times get here.

We'll see.

We’ll see what comes out on the other side.