Rival banks must work together to tackle climate change

Banks operate at the epicentre of the global economy. From small businesses to large corporations, bank financing enables companies to grow and to be run efficiently. As a result, banks have a crucial role to play in the transition to a low-carbon economy and in meeting the goals of the Paris Agreement.

To meet these goals, a proportion of existing fossil fuel reserves must stay in the ground. If all existing reserves were burned, the emissions released would cause temperate rises in excess of 2°C, causing catastrophic climate change. Faced with falling demand, competition from renewables, and policy changes, these unburnable reserves are at risk of being rendered uneconomical or “stranded.” This could result in $4 trillion of losses in the energy sector by 2035.

Under pressure from shareholders and civil society, and in response to these risks, many banks have amended their lending policies, with 45 restricting financing for coal. This trend must continue and accelerate, covering all new fossil fuel exploration. However, to effectively align their activities with the Paris goals, banks must also focus on the demand side of the energy equation – on those sectors that consume fossil fuels.

In electricity generation, renewables offer a cheap alternative that is both commercial and can be deployed at scale. But in industry and heavy transport, which together account for 30% of global emissions, the choice is less simple. As highlighted in ShareAction’s recent report on shipping, fossil fuels are hard to displace due to heavy loads and long journeys, while in cement and steel, emissions are embedded in the chemical reactions used in production.

Even though it is technically challenging to decarbonise these so-called “harder-to-abate” sectors, a “business as usual” approach cannot be an option. Infrastructure built today can last for decades, locking in high carbon emissions for years to come.

In addition, growing demand driven by economic development will result in rising emissions unless large cuts to carbon intensity are made. This underlines the importance of corporate decarbonisation initiatives, such as Science Based Targets, RE100, and EP100. Taken together, emissions from the harder-to-abate sectors are set to rise 50% by 2050, based on current country level climate commitments.

Banks, therefore, face a challenge. When lending to these sectors, how can they align with the goals of the Paris Agreement?

The shipping industry offers an effective paradigm. In 2019, the Poseidon Principles were launched by 11 banks representing 20% of global shipping loans. The principles require signatories to measure and disclose the carbon intensity of shipping loans relative to a target. In this case, the target is derived from the International Maritime Organization’s goal to cut emissions by 50% by 2050. Under the principles, for a bank to stay “climate aligned”, the carbon intensity of shipping loans must be reduced at a pace sufficient to meet this target.

Although still in their infancy, and not yet aligned with the Paris goals, these principles provide an unprecedented example of how banks can work together to tackle emissions. By agreeing to a uniform framework and full transparency, portfolios can be compared and contrasted, while the creation of a level playing field means that no one bank is at a disadvantage. The principles, which were coordinated by the Rocky Mountain Institute, were formed in consultation with the world’s largest container shipping company Maersk – ensuring that they could be implemented in practice.

Action is now needed in other harder-to-abate sectors. At present, the PACTA tool designed by the 2° Investing Initiative is being piloted by 17 banks, measuring climate alignment with a 2°C scenario in seven different sectors. The tool could become a new industry standard and enable banks to align with climate goals – a crucial step to ensure that they are not undermining the economic prosperity on which they depend.

As we enter the 2020s, the groundwork must be laid for the decade of delivery needed to meet the goals of the Paris Agreement. Financing must end for assets such as coal, which are incompatible with the low-carbon transition, but this is not enough. Harder-to-abate sectors must also be decarbonised. To achieve this, banks need to turn competition into collaboration, working with each other and with industry. The Poseidon Principles prove that this is possible, now it must be achieved across our economies. The world cannot wait.