The financial sector is becoming more and more aware of its vital role in assisting in the transition to a low-carbon economy and a sustainable future, as the world approaches a key turning point in the fight against climate change. The concept of net-zero banking, which seeks to integrate financial services with social and environmental sustainability objectives, is thus becoming increasingly important to the global efforts towards tackling climate change.
Banks must address every aspect of sustainability. However, presently, they seem to be contributing to both aspects of moving towards a green future. On the one hand, they support efforts to decarbonise the economy while on the other, they also help finance businesses that emit carbon dioxide. In this dual capacity, banks become potent catalysts that cause a seismic shift in the statistics related to climate change worldwide.
Globally, the market for sustainable finance is expected to develop significantly, with projections indicating that it will rise from USD 3.6 trillion in 2021 to USD 23 trillion by 2031.1
Net-zero banking
A bank's pledge to acheive net-zero carbon footprint by balancing the amount of greenhouse gases (GHGs) removed from the atmosphere with the amount released into the atmosphere
The need for net-zero financing
Since it is imperative that we confront climate change, the Intergovernmental Panel on Climate Change (IPCC)2 recommended keeping global warming to 1.5°C over pre-industrial levels in order to prevent any further deterioration of the global climate. However, the adverse consequences of climate change are unavoidable for global markets, as the current temperatures are already 1.1°C3 beyond the established thresholds. Therefore, businesses need to incorporate robust and effective net-zero initiatives into their fundamental operating frameworks in order to safeguard their long-term sustainability while responding to the changing environmental problems.
The rise of sustainable banking
The banking industry’s dedication to net zero goals is indicative of the growing popularity of sustainable banking practices. In 2023, the United Nations (UN) convened the Net-Zero Banking Alliance (NZBA)4, with a membership of 138 of the world’s top banks, spanning 44 nations and representing 41% of all banking assets, in order to address this developing threat. The global banking sector, which has an asset under management (AUM) of more than USD 9.5 trillion, has embraced the challenge of strategically aligning its operations and moving its lending and investment portfolio toward net-zero GHG emissions by 2050, in compliance with the Paris Agreement.5
Today, banks are generally cognisant of the collective stakeholder sentiment which is increasingly shifting in the favour of better sustainability ratings. The ‘environment’ and ‘sustainable’ components of ESG are being actively incorporated in the internal frameworks of banks, with the ‘governance’ aspect simultaneously evolving to cater to the former two components. This indicates an emerging era of responsible banking, where the focus is not only on traditional profit-centric models but also on the environmental impact. One of the major aspects within this paradigm is the consideration of financed emissions – i.e. emissions resulting from the projects and activities funded by banks.
Banks have often come under scrutiny due to their role in financing activities that contribute to GHG emissions. As societies and regulators intensify their focus on mitigating climate change, banks are increasingly evaluating the environmental impact of the projects they now fund. In order to finance green projects, support renewable energy efforts and encourage energy efficiency, they are implementing sustainable banking practices. This ultimately lowers the total carbon footprint linked to their financial activities.
Finance Minister Nirmala Sitharaman highlighted the provision of INR 350 billion6 (USD 4.2 billion) for the net-zero transition during the Interim Budget 2024 announcement in India. The Securities and Exchange Board of India (SEBI) has also developed a framework for sustainable issuance and modified the disclosure guidelines for green debt.
Green finance initiatives
Indian commercial banks have been supporting green finance programmes over the past ten years, allocating funds to projects aimed at fostering environmental sustainability. These programmes cover a wide range of sectors – such as sustainable agriculture, energy efficiency and renewable energy.
- The Reserve Bank of India (RBI) published a Framework for Acceptance of Green Deposits7 on 11 April 2023, with the goal of promoting, fostering and developing a sustainable financial ecosystem in the country.
With the implementation of this framework on 1 June 2023, banks and non-banking financial institutions (NBFCs) can be encouraged to offer green deposits, thereby facilitating the financing of environmentally sustainable projects and activities for their portfolio consumers. This framework is aimed at protecting the interests of depositors, helping clients achieve their sustainability goals, addressing issues with greenwashing and encouraging more credit flow to green initiative-aligned projects. - Establishing a comprehensive board-authorised policy, especially for green deposits, is mandatory for banks and NBFCs. All information pertaining to the issue and distribution of green deposits should be included in this policy. To guarantee the effective distribution of green deposits, these institutions must also put in place a Financing Framework (FF) that has been approved by the board.
- Of the 34 scheduled commercial banks in India, which include public, private and foreign banks, 85% agreed to make structural changes to their current lending and investing approach to support green financing, according to RBI’s Report of the Survey on Climate Risk and Sustainable Finance8, July 2022. Among other considerations, a majority of banks (56%) have also chosen to progressively lessen their exposure to companies that emit or pollute a considerable amount of carbon in the upcoming years.
Additionally, even though banking and financial institutions’ green efforts were already in the work-in-progress stage prior to the introduction of RBI’s framework, it provided Indian commercial banks an additional impetus and push to actively integrate the facilitation of green deposits for their borrowers. Let’s now examine the actions taken by a few banks in this regard:
In February 2023, India’s largest public sector unit (PSU) bank was able to secure a USD 1 billion9 syndicated social loan through two major international banks. This has been recognised as a notable milestone since it is the largest ESG loan secured by a commercial bank in the Asia-Pacific area and the second-largest social loan globally.
A major state-owned Indian bank and the Indian Renewable Energy Development Agency (IREDA)10 initiated a joint venture in September 2023 with the objective of enhancing credit activities within the renewable energy sector. The main areas of focus for the bank and IREDA, which include a wide range of renewable energy projects, are co-lending and loan syndication.
Another major Indian PSU Bank released a green deposit policy and lending framework in August 2023, adhering to the Green Deposit Framework established by the RBI. Offering green financing options to clients in order to support their transition to a sustainable future is the bank’s primary goal.
To promote innovation in the field of green hydrogen, a major global bank with operations in India teamed up with a well-renowned Indian management institution and a major sustainable energy foundation in August 2023.
As partnerships and cooperative efforts gain traction in the race towards net zero, several institutions are also taking the initiative to quicken the pace of green finance.
Although the net-zero objective has been defined, overcoming challenges posed by the same is not easy. Regulators, policyholders, consumers and other stakeholders are keeping a careful eye on these issues and putting pressure on banks to adopt proactive sustainable banking practices, creative thinking and strategic vision.
- Regulatory outlook: More transparency and risk assessment about climate-related issues are being pushed by regulatory authorities like the Task Force on Climate-related Financial Disclosures (TCFD). As part of these activities, banks will need to create thorough accounting records for the emissions they finance. This will involve examining the carbon footprint of the projects they support, evaluating their own emission reduction plans and spotting prospects for sustainable investments.
- Stakeholder expectations: Customers and investors alike are pressuring banks to operate more ethically and transparently. They are advocating for sustainable alternatives as their concerns about the effects of bank-financed projects on the environment grow.
- Accounting for financed emissions and annual disclosures: Banks will have to monitor, gather and examine data for financed emissions with great care. They will also need to use advanced techniques to determine the carbon footprints of different industries. In addition, they will have to make yearly disclosures since open reporting not only satisfies legal requirements but also builds confidence among interested parties and encourages prudent investment practices.
- Risk management and assessment: Banks are exposed to a variety of risks as a result of climate change – including transitional risks brought on by changes in market dynamics and policy, as well as physical risks from climate-related disasters. Thus, sophisticated risk assessment instruments and risk management frameworks are necessary for comprehending and reducing such dangers. These frameworks cover stress testing, scenario analysis and help create backup plans to handle the financial effects of climate-related disasters.
- Data analytics and technological investments: The foundation of climate-aware banking is complete and accurate data. It is essential to use cutting-edge technologies for accurate data gathering methods, climate risk assessment and carbon footprint measurement. Investing in state-of-the-art artificial intelligence and machine learning platforms and technologies would enable banks to make data-driven decisions and efficiently assess the emissions linked to their portfolios.
- Looking for opportunities: Banks will be in a better position to operate as dependable advisors and financiers during client business transition stages if they have a thorough understanding of the net-zero effects on their clients and actively participate in addressing their difficulties. Banks may position themselves as leaders in the emerging market by taking advantage of major climate finance opportunities by proactively aligning their operations with the Paris Agreement in the early stages of an engagement.
- Putting into practice a calculated and planned plan to smoothly incorporate net zero initiatives into portfolio composition, company objectives and business goals
- Using a proportionality and materiality-based strategy for focused action; quickly identifying focal areas by conducting a portfolio emissions heatmap aligned with the Partnership for Carbon Accounting Financials (PCAF)
- Ensuring reliable modelling of financed emissions estimates versus targets and reference scenarios by addressing data uncertainties with actuarial-inspired models and tools
- Making use of a variety of data sources to obtain emissions data at the asset level or to create proxies, filling in data gaps and generating estimates when emissions data is lacking
- Identifying gaps in transition planning through gap analysis to help banks focus on long-term strategic areas of attention as well as areas for improvement, disclosure or quick action
Way ahead
The banking sector is at the centre of a sustainable transformation as the world moves towards a net zero future. Financial institutions need to take the lead in promoting sustainability, resilience and environmental responsibility, as we negotiate the challenges posed by the fast-changing climate. The goal of net-zero banking is to create a future in which environmental preservation and financial prosperity coexist in harmony – and not just to minimise carbon emissions. Banks have the power to spark a significant shift that will lead sectors towards a more environmentally friendly and sustainable future by embracing sustainable finance products, improving transparency, strengthening risk management techniques and involving stakeholders.
Sources
- Confederation of Indian Industry (CII) - Rise of Investment in Sustainable Finance :
- Intergovernmental Panel on Climate Change (IPCC) - Global Warming of 1.5 ºC :
- UN-Convened Net-Zero Asset Owner Alliance - Increasing Climate Ambition, Decreasing Emissions :
- UN-Convened Net-Zero Asset Owner Alliance - Increasing Climate Ambition, Decreasing Emissions :
- United Nations Climate Change - The Paris Agreement:
- Bloomberg - India Plans $4.3 Billion Spending for Energy Transition :
- RBI - Framework for acceptance of Green Deposits, April 2023 :
- RBI - Report of the Survey on Climate Risk and Sustainable Finance :
- The Hindu – Largest loan by an Indian commercial bank in Asia Pacific :
- Economic Times – State Bank financing renewable energy projects :
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