Maintaining Decarbonization Momentum for U.S. Banks &… | ENGIE Impact

Maintaining Decarbonization Momentum for U.S. Banks and Financed Emissions

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Jeff Waller Senior Director, Head of Sustainable Finance
Green Finance
Emission Reduction

Like most major U.S. corporations, banks have spent the last half decade actively seeking ways to reduce their greenhouse gas (GHG) emissions. In some respects, banks are in an enviable position because their Scopes 1 and 2 emissions — direct emissions from their operations and purchased electricity — are comprised largely of its real estate portfolio (offices and branches) and computing, which are relatively low and fairly easy to tackle. But a bank’s Scope 1 and 2 emissions are vastly eclipsed by its Scope 3 — or supply chain — emissions. In particular, the emissions associated with banks’ financing activities represent the bulk of any financial institution’s emissions.

After meaningfully addressing their Scope 1 and 2 emissions, U.S. banks need to show continued progress and maintain decarbonization momentum — or risk being perceived as backsliding. They are therefore turning their attention to reducing their largest source of emissions: financed emissions. The pressure banks face to reduce this category of emissions is also driven, in large part, by the central role they play in the U.S. economy; investors and activists alike recognize that if banks incorporate strategies to lower their financed emissions into their core banking activities, it will help spur decarbonization in the economy overall. Another likely factor fueling the move to reduce financed emissions is the banks’ desire to stave off government regulation by showing the industry is adequately addressing the issue.

What are Financed Emissions?

All financial institutions — whether banks, hedge funds, insurance companies, or asset managers — have financed emissions. But those of banks — in particular, the largest U.S. banks — are the object of particular scrutiny given their widespread visibility and the fact that their primary activity (lending) touches large swaths of the U.S. economy.

Even within this one category, the financed emissions of some bank lending activities are easier to calculate than others. For example, if a bank provides 10% of a syndicated loan to build a gas-fired power plant, calculating the bank’s proportional share of the emissions is straightforward. But calculating financed emissions in the corporate banking context is more challenging. How does a bank calculate the emissions associated with a corporate loan or a bond underwriting? These questions are far from academic; in fact, U.S. banks have begun rolling out methodologies that shape how they make credit decisions for their corporate clients.

Each of the largest banks in the U.S. — Bank of America, Citi, Goldman Sachs, JPMorgan Chase, Morgan Stanley and Wells Fargo — is developing proprietary methodologies to calculate their financed emissions, or using existing frameworks, such as the Partnership for Carbon Accounting Financials. But their common starting point is the principles they adopted in 2021 when joining the Net Zero Banking Alliance (NZBA), an industry-led group of global banks that represent over 40% of global banking assets. At a high level, this means these institutions have committed to putting their portfolios on track to be Net Zero by 2050, but NZBA also requires signatories to set interim targets. Since 2030 is the first interim target year, these banks are now ramping up their efforts through four key activities:

1. Sector-specific Approaches

Given their vast client coverage, the NZBA-committed banks are creating sector-specific targets that track the scientific consensus of the reduction pathways necessary for a given sector to meet the Paris climate goals.

There are two approaches banks are using to set carbon reduction goals: decreasing the carbon intensity of their lending portfolio for a given sector or cutting financed emissions on an absolute basis. While the latter allows a bank to claim an unqualified cut to its emission exposure, this approach has limitations; a bank could drop a couple of high-emitting clients to achieve its absolute reduction goals, only for those clients to be picked up by other banks. In other words, the bank may eliminate these emissions from its balance sheet, only for them to appear on the balance sheet of another lender.

Alternatively, carbon intensity measures emissions produced per unit of output (e.g., carbon emitted per megawatt hour of electricity produced or mile of car driven). Ideally, a bank’s carbon intensity reduction targets should mimic the specific reduction pathways that scientists have established for each sector of the economy to limit warming to 2°C. Tracking this benchmark means banks are focused on broadly shifting entire sectors of the economy toward decarbonization rather than focusing on a handful of high-emitting clients. Some sectors — like oil & gas — do not have credible decarbonization trajectories, so some banks, such as Wells Fargo, are opting for absolute emissions reductions for those clients while retaining intensity targets for the other sectors. Yet, there is a significant risk that, as banks’ lending portfolios grow over time, their financed emissions will actually increase even as they meet their intensity targets.

Each of the major U.S. banks has charted their own course in calculating their financed emissions. The lack of standardization occurs at multiple levels: whether they choose intensity targets or absolute emissions reductions; how they draw the boundaries of the covered sectors; which GHG scope the consider for which sector; and what banking activities are excluded (i.e., capital markets, derivatives). As a result of this high degree of variability, investors, the banks’ own clients, and other stakeholders have a hard time evaluating the credibility of any one bank’s plans or comparing banks’ efforts across the sector.

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2. Incorporating Emissions Information into Credit Decisions

Banks have begun taking a client’s emissions profile into account as part of their credit decision-making process. Just as banks evaluate how a credit decision will impact the overall risk of their sector portfolios, they are now considering how a particular loan will contribute — whether positively or negatively — to their stated emission reduction goals for their loan portfolios.

For example, JPMorgan Chase developed a Carbon Assessment Framework that considers a number of factors to assign a score that reflects a client’s ambition and progress as it relates to decarbonization. This score then becomes one of the factors considered when making credit decisions.

3. Offering Financing for Decarbonization Projects

As corporate clients ramp up their decarbonization plans, the need for financing to support their transition will only grow. In response, banks have mobilized capital to address this need. For example, Bank of America and Citi have each established a goal to deploy $1 trillion toward sustainable finance by 2030.

4. Client Engagement

By definition, banks don’t exercise direct control over their financed emissions and can’t reduce them unilaterally. Therefore, they are increasing their engagement with clients on energy transition topics. This is perhaps the most nebulous and challenging of the strategies. But in general, it involves banks examining the GHG emissions profile, climate risk exposure, and transition plans of clients in target sectors to help identify which clients are outliers relative to their peers, and encouraging them to take steps toward decarbonization.

What Does this Mean for Companies?

In the near term, not all companies will be impacted equally by this focus on financed emissions. Banks are first developing a methodology to assess their financed emissions in the highest emitting sectors, such as oil & gas, transportation, and power. Companies with a more favorable emissions profile than their sectoral peers will be, all things being equal, a more sought-after client. Moreover, as banks ramp up their green lending, there are financing opportunities available for companies’ decarbonization projects, particularly in these target sectors.

What’s to Come?

Because the largest U.S. banks have established interim carbon reduction goals for 2030, the next few years will bring methodology refinement, an expansion of the sectors covered by this methodology, and a convergence or standardization of approaches.

Banks that are signatories to the NZBA are also under pressure to produce transition plans that align with the alliance’s guidance and detail how they intend to meet their 2030 and 2050 targets. This step is designed to increase lend credibility and accountability to the banks’ plans. This Spring, roughly 30% of shareholders of each of Bank of America, Goldman Sachs, JPMorgan Chase, and Wells Fargo backed resolutions requesting such plans be created. While the resolutions failed to reach the threshold for passage, they still garnered a significant share of the vote and a much higher level of approval than other climate-related resolutions. This signals that investors are increasingly expecting banks to substantiate their stated Net Zero goals with credible action plans.

As with any industry-led climate initiative, banks’ Net Zero plans should be welcomed, albeit cautiously. Absent regulation, banks are, in essence, both writing the exam and grading it. That is not problematic per se, but it does invite concern that the banks’ efforts will stall, and they’ll fail to meet their Net Zero goals in the necessary timeframe. Only continued scrutiny and engagement by a broad group of stakeholders — investors, NGOs, and the banks’ own clients — will ensure they stay on track.

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