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Climate Change
Banks are making climate commitments, but are they actually making a difference?
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MIT Sloan research finds that European banks’ climate commitments have yet to lead to significant lending changes that support a shift to net-zero emissions.
CAMBRIDGE, Mass., June 11, 2024 – Driven in part by pressure from customers and shareholders, more financial institutions have made voluntary climate commitments in recent years to help stall accelerating climate change. Banks, for example, that join the Net Zero Banking Alliance (NZBA) initiative, pledge to help limit global temperature increases by aligning their lending and investment portfolios with net-zero emissions by 2050, in addition to setting earlier targets.
Some applaud these climate-committed financial institutions for seemingly moving faster than policymakers to transition the economy away from carbon-intensive activities. But are voluntary commitments making a real difference?
In a new study, “Business as usual: bank net zero commitments, lending, and engagement,” MIT Sloan School of Management associate professor of finance and colleagues discovered they aren’t having much impact.
Along with Parinitha Sastry from Columbia University and David Marques-Ibanez from the European Central Bank, Verner found these so-called climate-aligned banks do loan less money to companies that are considered to be less climate-friendly. But the amounts loaned aren’t significantly less than loans made by banks with no voluntary climate commitment.
Climate-aligned banks also don’t charge higher interest rates to high-emissions firms – or lower rates to “green” firms – while their borrowers, in turn, aren’t more likely to set their own decarbonization targets. “These voluntary commitments, on their own, seem to not be having the effects that perhaps people are hoping they might have,” Verner said. “There’s been more talk than action.”
To arrive at their findings, the researchers used bank lending data from the European Central Bank from more than 300 banks. Around 10% of the banks had joined the NZBA, the largest and most stringent climate-related banking initiative. The NZBA includes 138 member banks from across 44 countries, representing over 40% of global banking assets. NZBA-aligned banks are required to set net-zero emissions-related targets for credit and investment portfolios within 18 months of joining the alliance.
The researchers investigated two key ways in which institutions can meet their NZBA climate commitments. For one, banks can divest from polluting firms and then reallocate that capital to less emission-intensive firms. They can also meet targets by influencing high-polluting borrowers to reduce emissions.
Verner and his colleagues found no evidence that the climate-aligned banks divested from sectors they pledged to focus their emission-reducing efforts on, including power generation, transportation and oil and gas. In fact, NZBA financial institutions were 3% more likely to enter into new relationships with firms in high-emissions targeted sectors than non-NZBA ones.
The researchers also discovered that NZBA-aligned banks gain a major benefit — their ESG rating as measured by Morgan Stanley Capital International (MSCI) rises by 0.6 points on average, a substantial upgrade, in the two years after they make their climate commitment.
Emil Verner, Associate Professor, Finance
“Overall, it seems like there have been substantial commitments that have not really translated into meaningful changes in these banks’ business models,” Verner said. The results are concerning since many believe the private sector will need to play a major role in the green transition. Results do call into question the effectiveness of voluntary climate commitments, said Verner.
Still, with initial targets currently several years away, there is time for banks to reverse course and make true progress. “We know from other circumstances that banks can change their lending very quickly,” he said.
More data and disclosure are needed. Banks could potentially make better-informed climate-friendly lending decisions if they had more information on borrowers’ emissions. Another possible way to encourage climate-committed banks to ramp up divestment and exert more influence over borrowers is to have a cost associated with not making progress toward fulfilling the climate pledge they’ve made.
Damage to banks’ reputations might be enough. “But it’s difficult to credibly score how banks are doing,” Verner said. “Currently, banks can almost write their own report cards. Maybe we need government policy to drive behavior.”
Also helpful, Verner added, could be insight into how loan contract structure can incentivize borrowers to become greener — and influencing borrower behavior is key. “This notion of divestment will only get us so far,” Verner said, “because other lenders can just step in, and you can’t destroy complete industries either by not lending to them. Helping industries to become greener is important.”
About the MIT Sloan School of Management
The MIT Sloan School of Management is where smart, independent leaders come together to solve problems, create new organizations, and improve the world. Learn more at mitsloan.mit.edu.
