Banking on Climate Action
Increasing scrutiny highlights growing divide between leaders and laggards, with asset owners attempting to close the gap.
The banking sector’s journey to net zero emissions has the potential to deliver or dash global climate ambitions – but that journey is fraught with challenges and complications.
Although most of the world’s largest banks have set climate commitments, the sector’s decarbonisation trajectory has long been shrouded in opacity, with visibility on progress hard to come by.
Most recently, momentum appears to have stalled, with banks adjusting their public positions in line with the ethos of the incoming Tump administration – watering down climate targets (or opting out altogether) and exiting the Net Zero Banking Alliance (NZBA).
This increasingly uncertain landscape makes it much tougher for asset owners looking to decarbonise their portfolios.
But asset owners’ eyes remain fixed on the horizon, as they dig in their heels and push for long-term changes from banks in their portfolios, in recognition of the fact that a net zero world depends on all facets of the financial system working towards supporting and financing low-carbon activities across markets and industries.
“If banks fail to align with net zero, the rest of the financial system – including asset owners like us – will struggle to meet our own climate goals,” Charlotte Sølling Grann, Senior ESG Officer at Danish pension fund provider AkademikerPension, tells ESG Investor.
“Worse still, without committed banks, the real economy’s pathway to net zero becomes far more uncertain.”
Taking stock
Before diving into how asset owners are engaging with banks to drive progress, it’s worth reflecting on exactly what they are up against.
“A major challenge [for asset owners] is the ongoing lack of comparability across banks’ targets and reporting,” says Sølling Grann.
“Many sustainable finance commitments are headline-grabbing but difficult to assess in terms of ambition or credibility, because the methodology behind the headline remains mixed or undisclosed, masking banks’ true exposure to transition risks.”
Part of the problem is their differing business models.
“One might have a big mortgage book, while the other is more focused on corporate financing – and then there are the asset management arms to consider,” says Katharina Lindmeier, Head of Sustainability Strategy at UK pension scheme Nest.
Comparing banks on their climate progress therefore requires a broad approach, she says, including comparison of their overarching climate-related commitments and sectoral targets.
“But of course banks will pick different sectors, so we must first evaluate how material those sectors are to their lending book and facilitated emissions,” Lindmeier adds.
“We also need to think about loans versus capital market activities, and to what extent those are included in sustainable finance targets. More recently, we’ve looked at audit assumptions and lobbying activities.”
Sameed Afzal, Senior Stewardship Analyst at LGPS Central, says banks are typically prioritising target-setting in sectors with the highest absolute emissions and “where decarbonisation pathways are clearest”, such as power generation, coal, and oil and gas.
He notes that the UK local government pension pool (LGPS) sees fewer targets in sectors where the path forward is less clear, such as agriculture.
The Trump effect
Comparability is also increasingly challenging geographically, as the transatlantic divide widens.
“While European banks face justified criticism for methodological inconsistencies, many are still moving in the right direction – setting sectoral targets, aligning with 1.5°C scenarios, and linking capital allocation to decarbonisation pathways,” says Sølling Grann at AkademikerPension.
The climate performance of European banks is becoming easier to compare in part thanks to regulation. The European Banking Authority’s implementation of Basel III includes Pillar 3 reporting requirements that stipulate annual template-based disclosures on physical and transition risks, plus two metrics that measure changes in the exposure of bank assets to climate change.
Meanwhile, the mass withdrawal of major US banks from the NZBA signals a “worrying backlash”, she says.
At the beginning of this year, asset owners could only sit back and watch as large US banks exited the NZBA, ahead of the inauguration of President Donald Trump and more political action against climate action.
“Some US banks are distancing themselves from the level of transparency and ambition required to align with the Paris Agreement,” says Sølling Grann.
US banks have been followed by banks from Canada, Australia and Japan, suggesting that cracks have stretched well beyond US foundations.
“Several banks that have withdrawn from the NZBA and other collaborative initiatives have failed to disclose credible sectoral decarbonisation plans or maintain robust engagement frameworks,” says Sølling Grann.
“Many continue to finance fossil fuel expansion at scale with no clear criteria for transition – placing them behind their European counterparts.”
Meanwhile, the World Bank reports that climate financing makes up just 5% or less of the lending portfolio of nearly 60% of emerging market banks – with 28% of them providing no climate financing at all.
“This leaves European banks relatively ahead – not because they are perfect, but because they are at least trying to move in the right direction,” says Sølling Grann.
Even being a member of the NZBA does not always guarantee that a bank is making strong climate progress.
Members have faced widespread criticism concerning their lack of transparency on their climate commitments and progress, with research finding little to no difference between the financing and engagement impact of members versus non-members.
Earlier this month, the NZBA voted in favour of adopting changes to its framework, in a bid to introduce more flexibility to members. Most notably, it has relaxed its stance on Paris-alignment, arguing that there are a “wider range” of net zero pathways that align with the Paris Agreement, as opposed to 1.5°C.
“Divergence underscores the importance of evaluating firms based on their tangible actions rather than their affiliations,” says Afzal at LGPS Central.
“We have never seen [NZBA] membership as a deal breaker. We try and look deeper into what an organisation is actually doing and how they can deliver on their net zero commitments; memberships are invariably not critical to this delivery.”
The pay-off
There is success to be found for asset owners prepared to take a more hands-on approach to engagement.
“We prioritise engaging with banks on publishing and disclosing targets, sectoral breakdowns, credible transition plans for clients, and green financing,” says Sølling Grann.
She points to the asset owner’s ongoing engagement efforts with HSBC. In 2020, AkademikerPension, together with other investors, submitted a shareholder proposal urging the bank to stop financing coal power.
“Following negotiations in 2021, HSBC submitted a management-backed resolution committing to phasing out coal financing,” says Sølling Grann.
“While their 2021 coal phase-out plan was a step forward, we found it fell short of Paris-alignment. As a result, we co-filed another shareholder resolution in 2022, again in collaboration with other investors and ShareAction, and the bank has since updated its fossil fuel policies. We continue to engage with HSBC and met with representatives this year.”
In 2023, as part of a collective engagement with ShareAction, LGPS Central wrote to five European banks, including Barclays, requesting they stop directly financing new oil and gas fields.
The pension scheme escalated its concerns by filing a shareholder resolution at Barclays requesting it report on the risk of stranded assets associated with financing oil and gas infrastructure.
“The resolution was withdrawn following engagement with Barclays senior leadership team, resulting in a commitment to stop financing new oil and gas fields and to restrict lending more broadly to energy companies expanding fossil fuel production,” says Afzal.
Later that year, LGPS Central and a handful of other investors met with the Barclays CEO to get reassurance that the commitment was being followed through.
Even US banks have proven open to climate ambition.
JP Morgan recently began disclosing its energy supply financing ratio – offering a transparent comparison of its financing for low-carbon energy versus carbon-intensive energy – following engagement with the New York City pension funds.
Some banks have gone further, cementing their status as climate leaders in the sector.
Crédit Agricole has committed to tripling its renewables financing, multiplying its financed terawatt hours of renewable energy by 3.6 times by 2030. Fellow French bank BNP Paribas has set a target for renewables to make up at least 66% of its power generation portfolio, and electric vehicles at least 25% of its automotive portfolio, by 2025.
Some Nordic banks are showing encouraging leadership, according to Sølling Grann.
“Danske Bank, for example, deserves recognition for its strengthened fossil fuel policy, including exclusions on upstream expansion and expectations for transition plans. Though we note there is still room for improvement, we believe it is one of the stronger frameworks in the sector.”
Tools for change
Distinguishing the leaders from the laggards has required the development of bank-focused climate guidance and tools.
Experts speaking to ESG Investor flag the Transition Pathway Initiative’s (TPI) Net Zero Banking Assessment Framework (NZBAF) and Transition Plan Taskforce’s Banks Sector Guidance as tools that effectively support their efforts assessing banks’ approaches to climate risk management across governance, target-setting and carbon performance.
In addition, the Institutional Investors Group on Climate Change runs the Banks Engagement and Research Initiative (BERI), which incorporates the TPI’s assessment framework and has an engagement focus list of 20 banks.
The Science Based Targets initiative’s much-anticipated Financial Institutions Net Zero (FINZ) standard is also expected to provide a rigorous framework to help banks increase their climate-related transparency and ambition. It will build upon updated near-term target-setting criteria, ensuring that interim emissions reduction targets set by investors, insurers and banks are aligned with their long-term net zero commitments.
In line with this guidance, asset owners have been able to gain an understanding of what best practice should look like.
“Good practice involves ensuring banks have a holistic approach to climate risk management, encapsulating the broad scope of their activities,” says Afzal.
“Clear transition strategies should outline the banks’ strategic ambition, implementation and engagement strategies, use of appropriate metrics and targets, and governance models that support their approach.”
Work in progress
Headlines still cause concern for those that recognise banks’ transmission role to the wider economy. Barclays and NatWest recently struck climate targets out of senior executives’ incentive schemes. HSBC pushed back its forecast for reaching net zero to 2050.
Shareholders will soon get a chance to share their feedback on such actions, with several major UK and European banks holding their AGMs in the first half of May.
Asset owners understand that the road to net zero is far from linear and are prepared to engage with the banking sector on climate for the long haul, continuing to push for more ambition.
Afzal at LGPS Central says the pension scheme would like to see a wider integration of just transition considerations into banks’ transition planning – including disclosures on how they identify, assess and account for the impacts and dependencies of their strategy on stakeholders.
In addition, more focus is needed on reporting facilitated emissions, he says.
“One of the sectors within banking activities that many are struggling with is mortgages – or, more broadly, residential and commercial real estate,” says Lindmeier at Nest.
“Going forward, we would like to see more climate targets focused on residential real estate and what banks plan to do around green mortgages.”
A green mortgage offers preferential terms – such as lower interest rates – for buying or improving energy efficient properties.
Research conducted by the UK’s Mortgage Advice Bureau earlier this year found that 52% of surveyed mortgage lenders currently offer green or energy efficiency-linked mortgage products. However, 35% said not enough progress has been made in this space.
The hard-to-decarbonise real estate sector can be a major source of financed emissions either through an asset owner’s own property portfolio or via holdings in UK banks– which typically have a lot of exposure to mortgages, Lindmeier explains.
Nest is also going to be looking for increased transparency surrounding climate lobbying.
“We would like to see clear policies around how banks are engaging with policymakers on climate – directly and through industry associations – as the whole sector could be stronger in this area.”
Sustainability-focused regulation has helped to drive climate progress in the European banking sector. A 2024 report by the European Central Bank found that eurozone banks were charging companies in the top 25% of carbon emitters monthly interest rates14 basis points higher on average than those in the lowest 25%.
As climate policies and regulations become increasingly scrutinised, this strand of engagement will likely be a growing priority for responsible investors, she warns.
“While the banking sector has made notable progress in transitioning to net zero, significant challenges remain,” says Afzal.
“The role of asset owners in driving this transition is critical, and their engagement with banks can create meaningful change.”
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