Why divesting from fossil fuels is easier said than done for banks
The 2008 subprime crisis.
Banks and financial institutions that were highly exposed to subprime assets saw their value drop by more than 80%. Subprimes became stranded assets.
Initially limited to real estate and finance, the crisis snowballed into the biggest financial crash and global recession - the worst crisis the world had seen since the great depression of 1929.
Why are we still talking about the 2008 crisis? Because it holds some truths about the climate crisis. The Banking On Climate Chaos 2021 report reveals that between 2016 and 2020, the 60 largest banks in the world granted 3,393 billion euros to companies in the fossil fuel sector.
However, in upholding the Paris Agreement signed in 2015 (by 192 countries plus the European Union), countries are obliged to end fossil fuel dependency and gradually phase them out. Global coal, oil, and fossil fuel production must be decreased by 6% every year by 203o to give humanity a fighting chance to limit global warming to 1.5°C - a path at odds with current financial flows.
Before the Paris Agreement, banks, and financial institutions accumulated billions in assets related to the exploration, development, transportation, and use of coal, oil, and gas. These ‘fossil assets’, which were once critical to the stability of the climate and the financial system are now at the risk of becoming stranded assets. The inevitable ecological transition could produce significant turbulence, whatever the speed may be - it could bring banks to bankruptcy. This mirrors the subprime mortgage crisis - denying the looming catastrophe might lead to an avoidable crisis, resulting in many bank failures.
Much like the 2008 financial crisis, banks are among the primary accused of fueling the climate crisis.
© Andy Buchanan/AFP/Getty
Frustration with the banking industry is gaining currency — in particular, the sector’s role in financing fossil fuels.
Like a smoker who cannot quit, banks are addicted to fossil fuels. Despite the damage it causes, the addiction persists.
Contrary to the bold, ambitious promises to move to clean energy sources, Indian banks rank fourth globally in financing coal plants - providing nearly $155.6 billion in loans between 2012 and 2019, according to a report titled ‘How central banks are fueling climate crisis’ by Oil Change International. India’s largest public sector bank, State Bank of India (SBI), is among the 60 banks to have loaned $26.5 billion between 2016 and 2021 to companies in the fossil fuel sector.
These figures indicate the inadequacy of policymakers simply waiting for financial institutions to self-regulate and align their funding with climate goals.
But like any dangerous addiction, quitting can be difficult and require more support.
I suspect there are a few reasons why banks have not been able to align themselves with climate goals the way activists and the general public has been demanding -
Transition Risk
The threat of financial disturbances along a decarbonization path has important implications. This study looks at the fossil fuel assets of 11 EU banks - they represent 95% of the banks’ total equity. To absorb that look, they’d have to mobilize a high share of their equity.
The study only considers ‘tip of the iceberg’ fossil assets, or assets directly linked to fossil fuel companies. If other industries in the value chain, like automotive, aeronautics, and petrochemicals were considered, the spiral of financial loss would be far more dizzying.
Another report by insurance company Swiss Re calculates what a carbon tax of $100 per tonne would imply - a drop in revenue ranging from 40% to 80% for energy companies (depending on geographical area); credit losses for electricity, oil, gas production, between $50-$300 billion.
It’s unlikely that such catastrophic consequences would happen over a few weeks. However, even if the loss in value of these assets is spread over the years, the risk remains the same. I’d like to think banks are aware of the seriousness of the risk in the medium and long term.
I’d also like to think that they’re reasoning backward today, to gain time by slowing down the ecological transition as much as possible.
IEA v IPCC
Take the Net-Zero Banking Alliance (NZBA) - the most promising private sector-led initiative aimed at decarbonizing the global economy. Unlike other climate-minded initiatives from financial institutions, like the ESG investments, the NZBA has a bigger potential to influence major private-sector greenhouse gas (GHG) emitters to cut their emissions.
The NZBA includes HSBC, Bank of America, and Santander. It calls on lenders to set targets around climate change scenarios put forward by either the UN’s IPCC or the Paris-based IEA, the oil producer countries' organization.
And although the IPCC and IEA scenarios have largely similar outcomes in terms of global warming, the key difference is that the IEA lays out a road map that specifically includes a ban on fossil fuel exploration projects and the IPCC does not.
A Financial Times article reveals that there have been disagreements in the NZBA over which roadmap to adopt. The UN Environment Programme Initiative (UNEP FI), the acting secretariat for the NZBA, favors the IPCC report (since it is a sister organization within the UN). However, leaked emails have shown that advisors to the NZBA have favored the IEA road map, but have been met with resistance.
Green finance - is it hogwash?
Since the Paris Agreement was signed in 2015, green finance has gained prominence. A large number of sustainability labels were created. ESG Funds - Environmental, Social, Governance - are seeing growth in numbers as well as volume. In India alone, ESG funds increased 2.5 times to $650 million in 2021 on an annual basis.
Several financial institutions are also green-washing their communications - one in eight financial institutions' ads from January to July 2020 used sustainable finance to promote specific products, attract new customers and encourage savings. In 2019, this was only one in 12 ads.
Sustainability cannot merely be branding. But, it is. There’s no legal requirement for these sustainable financial instruments; A green label doesn’t guarantee real environmental quality; more importantly, none of these green labels guarantee the exclusion of fossil fuels from a fund and neither do they ensure compliance with the Paris Agreement.
According to As You Sow, a nonprofit that promotes environmental and social corporate responsibility, “Fossil Fuel Reserves Free” ET - has holdings in 23 fossil fuel companies, including ones in coal and oil and gas. It’s under 2% of the overall fund, but it’s not nothing. Likewise, and once again due to a nearly non-existent framework, large companies can use green bonds as a greenwashing tool with the complicity of banks.
Are we living in a Fuel’s paradise?
If you’ve been feeling some pain at the pump in recent weeks, you’re not alone. Gas prices are up around the world, and in India, they recently reached a new all-time high. There are multiple reasons for this - the Russia-Ukraine conflict, production limits set by OPEC, India’s central government cut excise duty and several states followed suit with a reduction in value-added tax to ease the burden on consumers.
These high prices are a victory for climate change then right? This is what the climate change hawks wanted all along? Wasn’t this supposed to be the outcome of pushing for a carbon tax? Higher fuel prices?
If you believe fossil fuels are destroying the world, then high fuel prices are a victory, yes? Of course, the current rise in prices isn't because of a carbon tax, but the results are much the same. High prices lead to lower consumption, and people turn to alternate modes of transportation or avoid it altogether.
Imagine climate alarmists walking into a petrol pump and still being unhappy - ‘fuel prices aren’t high enough. Sounds ridiculous, but it seems to be the logical conclusion of the fossil-fuel warrior proposition. If you want a world with zero fossil fuel consumption, what better way to achieve it than by making fossil fuels prohibitively expensive? And how do we get around without fossil fuels? Just use Electric Vehicles (EVs). Cool!
EVs are expensive, reserved for the privileged, and also make an important economic idea - consumer decisions in a free market. People gravitate towards the cheapest option in a free market, because, by definition, it is more economical. So the fact that people are choosing fuel cars over EVs reiterates the free-market theory. If it was cheaper to switch to EVs, they would be out of pure self-interest.
The cost of buying and driving an EV represents a tipping point. As long as fuel is cheap enough, fuel cars will be cheaper overall and people will continue to use them. But, if fuel prices continue to rise, at some point, EVs will naturally be more economical.
But there’s an important caveat - consumer decisions only show the economic superiority of a product. Introduce special taxes, regulations, and subsidies that tip the scales towards one product and people will choose the more uneconomical product.
For example, if there are significant tax credits for EVs that aren’t available for gas cars, the effective price of EVs will be artificially lower, which means people will gravitate toward EVs even though those cars might be more expensive to create.
But, if you feel the need to entice/enforce people to adapt to your alternatives, there’s a good chance your alternative is economically inferior.
Scientists have established it is much safer to limit global warming to 1.5°C. So human-made carbon emissions, much of which come from burning oil, gas, and coal, should nearly halve by 2030 and fall to net zero by around 2050. Long story short: We have about 30 years to wean ourselves off fossil fuels, that makeup about 80% of the energy mix, and ditch plans to dig up more.
It's a stretch, not that it's not necessary. But think about it - banks are at the center of the crisis. It can only mean that they hold power, but not all of it. Governments hold the power. Here’s some proof -
Fossil-fuel subsidies are one of the biggest financial barriers hampering the world’s shift to renewable energy sources,
There have been issues with measuring the impact of the carbon tax
The impact of carbon pricing on carbon emissions typically ignores the role played by international transportation.
Several studies have shown that purchases of corporate assets by the ECB are biased in favor of the most carbon-intensive activities.
Some of the widely acknowledged solutions to the climate-bank problem are creating climate bad banks, financial regulation must include climate change, better integration of systemic risks of climate change on banks (to assess the physical climate impacts and how it could destabilize markets)
What’s the promise of climate fintech?
Much like fintech, climate fintech also works on the idea of providing a layer of tech innovation to address sustainability and financial needs. This means innovation in investment in battery technology, carbon sequestration, reforestation, renewable energy, electrification, energy efficiency, and other cutting-edge carbon removal technologies.
However, according to The International Energy Agency (IEA) and International Monetary Fund (IMF) green recovery plan, roughly $3 trillion needs to be invested into these climate solutions over the next three years to achieve a 1.5-degree warming scenario... a figure more than 4 times current investment levels.
This April, financial services and credit card company Mastercard partnered with Swedish environmental fintech company Doconomy to develop the Mastercard Carbon Calculator. The calculator shows customers the carbon footprint of their purchases across different categories of spending in an app or online portal.
But the promise of climate fintech in mitigating climate extremities is limited to how much government intervention there is. Otherwise, it might also end up as a greenwash that nobody asked for.
Climate change IS REAL
Often with climate change, it's easy to misunderstand how quickly the dangers are rising. Already the world has warmed 1.3 degrees above the pre-industrial levels.
Nearly all of the world’s governments made new pledges to cut carbon emissions. Unless there is widespread adherence to promises that are still not yet concrete policies, the Paris Agreement’s goal of “well below” 2 degrees is unlikely to be met.
A Brookings survey revealed that markets are aware of the transition risks, but what they’re not calculating is the physical risks of climate change, such as floods and heatwaves.
“These dangers are under-assessed: Climate-related financial disclosures are about half as likely to look at the physical impacts of climate change compared with transition risks.”
Money has an enormous power to move the lever and daily actions that people can take
To feed the illusion that a single actor, be it a private bank or a central bank, could solve all challenges presented by the transitional risks and stock of fossil assets alone, is absurd. The physical risk climate change poses for our societies, economics, including banks, insurance companies, and the real economy, is a complex systemic problem. It needs to be tackled with real democratic debates, without letting taxpayers massive economic, environmental, and social damage while footing the bill.