01 October 2024

CEPR's Hale, Meisenbacher, Nechio: Banks’ climate commitments and the green transition

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.

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. 

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....

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