Banks and climate change, what are the prospects?

There ECB has updated its climate-related indicators, which provide insights into both how financial markets are coping with the green transition and how financial institutions might be affected by climate change. The data that has emerged reveals that we are witnessing progress in the case of sustainable bondsof the financing of carbon emissions through bank loans and protective measures against financial losses resulting from floods. On the other hand, Eurotower admits that “there is still a lot to do”.

Transparency in the green bond market

The ECB explains that more and more debt securities issued in the Eurozone and globally they are green, social or sustainable or in any case related to sustainability. Overall, although the market share of sustainable bonds has grown by 50% since 2021, it remains quite modest to 6% of the overall market.

The ECB indicator distinguishes between self-declared sustainable bonds, i.e. qualified as sustainable by those who issue them, and those that have received an external assessment. About 85% of all debt issues sustainable in the EU have received this double judgement and practically all the “green” bonds issued have obtained at least one rating. The additional ratings provide investors with reassurance that green bonds are indeed what they claim to be.

The “greenwashing“, that is, making false or misleading statements about the environmental benefits of a product or practice is grounds for concern for investors and thus third-party opinions reduce the space for greenwashing, increase transparency and help strengthen trust in green financial markets.

Banks' loan portfolios

The ECB indicators provide information oncarbon intensity of the financed economic activities from securities and loan portfolios of the Eurozone financial sector and on the sector's exposure to counterparties with carbon-intensive business models. The indicators show a generally downward trend between 2018 and 2020but the indicator increased slightly in 2021. This increase may be the result of increased economic activity due to the easing of pandemic restrictions.

However, this it doesn't mean banks are greening their portfolios loans. Funded issuance reductions can theoretically come from two sources: from issues in the loan portfolio or from a general decrease in the bank's investment ratio. And in fact, they are the companies that are instead investing in activities with lower emissions.

The impact of loan guarantees

A series of indicators allows the ECB to analyze the impact of natural risks, such as floods, fires or storms on the performance of banks' loan, bond and equity portfolios. Risk scores, which divide risk into categories, are the most widely used measure, but they do not allow comparisons between different risks. Instead, there is an indicator that aims to quantify potential losses in financial terms.

Capturing the financial impact helps in evaluation the effectiveness of climate adaptation measures (such as flood defences) and strategies financial mitigation (such as collateral pledged with loans). For example, the recently introduced Collateral Adjusted Risk Exposure (CEAR) indicator provides an aggregate estimate of expected losses within the banks' portfolios considering various loan protections. These could be, for example, financial or real estate guarantees.