According to the recent report, "Banking on Climate Chaos," since the Paris Agreement was signed to much fanfare in 2015 at COP21, the world’s 60 largest banks have financed $4.6 trillion in fossil fuel projects, according to the recent report, "Banking on Climate Chaos." There was $742 billion in fossil fuel financing in 2021 alone.
By comparison, in the five years following the Paris Agreement there has been about $203 billion in bonds and loans underwriting renewable energy projects. That is about 5 percent of the total dedicated to fossil fuel projects. The pace of investment in renewables has picked up since then but is still dwarfed by financing for fossil fuels.
According to the "Banking on Climate Chaos" report, fossil fuel financing comes primarily from four large U.S. banks — JPMorgan Chase, Citi, Wells Fargo and Bank of America, which together account for about a quarter of all fossil fuel financing in the last six years. The pace of this doomsday banking is not slowing very much, according to the analysis. In 2021, JPMorgan financed about $61 billion in fossil fuel projects, compared to $68 billion in 2018. Citi financed $48 billion in 2018 versus $41 billion in 2021. Wells Fargo financed $61 billion in 2018 versus $46 billion in 2021. Bank of America financed $34 billion in 2018 versus $32 billion in 2021.
We are incentivized to destroy ourselves, so that is what we do
As much as we like to consider ourselves sophisticated and intelligent, we as human beings are relatively simple creatures. In the end, like any animal, we do what we are incentivized to do.
Under the current system, we are incentivized to destroy ourselves. Our culture, our economic systems and our markets all tend to incentivize short-term choices over long-term ones. Short-term advances brush away the long-term consequences of those advances. Like burning fossil fuels to turbocharge human development.
This gets us to what is motivating the leaders of the world’s largest financial institutions to make decisions that are dooming those in their family who will eventually inherit their considerable wealth. Do bankers really hate their grandkids? I’m sure they will tell you "No." But the evidence points to "Yes."
Governments around the world still heavily subsidize fossil fuels. This plays into the calculus of bankers who continue to finance oil, gas and coal projects.
After a few days with my kids, I do notice my parents get a bit tired of reading to them and playing games with them. But I don’t think that after a long weekend with my kids, they are plotting ways to destroy the future for my children. I’ll ask them next time I see them.
Maybe some bankers do hate the young people in their families, but the simpler answer is that they are following incentives. Their compensation and legacy are almost always tied to relatively short-term goals. Tying compensation to sustainability goals is a tricky thing. What goals are suitable targets and somewhat under an executive’s control? Boards need to do a better job of tying longer-term compensation to sustainability goals. The best cases, of course, would link a meaningful part of long-term compensation to the success of the company after an executive leaves.
Tools like the recommendations from the Task Force on Climate-related Financial Disclosures and the Taskforce for Nature-related Financial Disclosures are good resources that investors and companies can use to ensure climate and natural capital measurement and management are baked into corporate strategy.
Perverse incentives are in the law and tax code
Governments around the world still heavily subsidize fossil fuels. This plays into the calculus of bankers who continue to finance oil, gas and coal projects. If governments are still sending signals that they are incentivizing the continued dominance of fossil fuels, then bankers will make those loans. If those subsidies went away, that takes away a big incentive.
We as financial people are great at discounting future cash flows. It is one of the first things you learn in your finance class or MBA program or while studying for the Chartered Financial Analyst certification. If lawmakers and policymakers drew down fossil fuel subsidies at a faster pace, a large part of the incentive to invest in an apocalyptic future would be gone.
It is hard to underestimate the impact of fossil fuel subsidies. A recent study by the International Monetary Fund (IMF) found that coal, oil and natural gas receive about $5.9 trillion in subsidies as of 2020. Direct subsidies account for only about 8 percent of that total. The rest are indirect subsidies such as tax breaks, but the IMF also included the costs of health and environmental damages not priced into the cost of fossil fuels. According to the report, efficient fuel pricing in 2025 (read, getting rid of fossil fuel subsidies) would reduce global carbon dioxide emissions 36 percent below baseline levels, while raising revenues worth 3.8 percent of global GDP and preventing 0.9 million local air pollution deaths.
Those costs the IMF mentions are real impacts on people’s lives, but I can hear the pedantic among us saying, "Those costs aren’t really subsidies." True enough, but direct subsidies still distort the market. A more conservative analysis estimates that direct subsidies to U.S. companies as recently as 2019 were about $20 billion and 55 billion euros in the European Union.
We also need to consider that many of these subsidies were codified in law decades ago. This means the beneficiaries of these subsidies are often entrenched interests with a significant financial incentive to protect the status quo. These folks hate their grandchildren in the same way that bankers do.
Subsidies are also complicated. Take the example of fossil fuel companies that are benefiting from wind subsidies in Texas. Is this good, bad, should we be indifferent? The proof is in the result. Is a law, rule, subsidy, compensation package or other action incentivizing the kind of behavior a society needs for let’s say — long-term survival. If not, it may be time to scrap it.
Change the culture, change the world
All these perverse incentives are ingrained in our culture. Large-scale cultural changes take time.
There are efforts underway to change bank culture and provide educational resources to better create a culture of climate consciousness in banks. There are many ESG and climate change curriculums circulating that are heavily subscribed by financial professionals. I’ve looked at many of them (I’m running out of space, so maybe that is a different column), and most of them are useful. The U.K. nonprofit Finance Innovation Lab (FIL), is one such example. FIL offers a bootcamp for bank staff to get them up to speed on climate issues and how to incorporate them into what they do.
A change in culture at these financial institutions is imperative, so climate action becomes something that the bank staff feels equipped and empowered to move forward, not simply a mandate from the C-suite.
We’ll get there. But will it be because we changed our culture or because our financial system and our society collapsed under the strain of environmental degradation and our grandchildren must start over?