The climate challenge has been so difficult to overcome in part because of what economists call "externalities" or problems outside the economic system that can’t be addressed by one company or nation on its own. Carbon emissions are by far the global economy’s biggest externality, and as a result, no single group has been held accountable for reducing them.
Banks are stepping up to the challenge. The new United Nations-convened group known as the Net-Zero Banking Alliance brings together 53 banks from 27 countries with $37 trillion in assets. Their historic pledge is to reach net-zero carbon emissions across their lending portfolios by 2050. It’s part of the broader Glasgow Financial Alliance for Net Zero, which also includes asset managers shepherding more than $70 trillion of the world’s assets.
What makes the pledges so significant is that not only have banks demonstrated a high commitment to the issue by placing their credibility on the line, they also have invited the world to check their progress along the way in shifting capital toward companies making the net-zero transition.
Banks are especially well suited to influence corporate behavior. Not only do they make loans to corporations, they also underwrite corporate stock and bond offerings and manage investment portfolios. They have enormous expertise across their organizations that they can tap to help their clients make the transition and communicate with stakeholders such as regulators, shareholders and communities.
But banks can’t push mankind to net-zero carbon emissions by themselves. Even in Europe, which is far ahead of the U.S., there is a $4 trillion mismatch between the available pool of money and the corporations that qualify as Paris-aligned, according to a recent report by CDP-Europe and Oliver Wyman.
How can banks achieve net-zero?
For banks to make good on their pledges and help reduce global carbon emissions meaningfully, the broader incentive systems driving global business activity need to be realigned in numerous ways.
First, companies need a universal way to estimate the volume and cost of the carbon they emit. Right now, it’s a mixture depending in part on jurisdiction. Forty countries and 20 cities and regions have implemented carbon prices, charging companies a tax or fee for each ton of carbon emitted. But the prices vary widely.
A global carbon price, driven by collective policy actions and market dynamics, would provide much needed clarity. But getting one won’t be easy as there is no governing body powerful enough to enforce this across the globe. If some prominent international body — for example the G20 — were able to reach an agreement among member nations, that could help set the tone for the rest of the world.
Likewise, banks need international agreement on the proper accounting practices for carbon so they can all measure their progress the same way. No one is entirely sure how much carbon companies are producing because the data aren’t readily and universally available. Banks will need to develop standards for their own use, but those might differ.
In addition to a stronger emissions database, the net-zero future won’t come about without a more coherent global approach to climate policy.
Authorities could help by creating standards so that all companies use the same language when reporting their carbon activities. The International Financial Reporting Standards Foundation, based in London, is aiming to create such standards by mid-2022, and the SEC has invited public comment for climate disclosure rule making.
Skeptics will note that central banks weren’t created to enforce climate policy. But they do seek financial stability. Banks face major risks from climate change, such as loans made to companies in coastal areas at risk of rising ocean levels and tidal flooding. If one bank takes a big hit, others will suffer.
France’s central bank governor told the Financial Times in June that "climate-related risks are part of financial risks. And so for financial institutions and supervisors as well, it’s not a nice-to-have. It’s not part of [corporate social responsibility]. It is a must-have and it’s part of risk management." The Bank of England’s Prudential Regulatory Authority asks banks to measure their climate exposures, while the European Central Bank is running a climate stress test and French regulators launched a pilot exercise in which banks and insurers measured their financial exposure to climate risk to 2050.
Banks also need the ability to track carbon emissions around the world. While company emissions data are available from multiple sources, these information sets aren’t exhaustive. Imagine a single, perfect database that not only would help banks steer capital appropriately but also would help scientists model carbon levels and atmospheric conditions more robustly and come up with a real-time global carbon budget that could be constantly monitored. We are seeing breakthroughs in this arena through low-orbit satellites monitoring methane and the emergence of tech startups that measure and track emissions.
In addition to a stronger emissions database, the net-zero future won’t come about without a more coherent global approach to climate policy. While banks can dispense advice and provide capital, companies must embrace the net-zero agenda — and they might need incentives such as tax breaks, subsidies, public contracts or research to be nudged in that direction.
For example, an airline might find it uneconomic to reach net-zero emissions — but if governments were to require that half their aviation fuel come from sustainable sources, their progress would rapidly accelerate. Think of it as a three-way partnership: the public sector, together with banks and companies, can help create and finance new solutions.
Banks are taking a commendable step in the climate fight. But if the rest of the world fails to figure out the correct financial incentives, metrics and policies, their ambitions will remain forever out of reach — even as the mercury continues to rise.