Carbon accounting in banks: Financial services are becoming more transparent

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  Quantumrun Foresight
• July 6, 2023

Insight highlights

Banks are increasingly committing to reduce financed emissions in line with the Paris Agreement, a complex process requiring careful evaluations and adjustments. Membership in the Net-Zero Banking Alliance and the Partnership for Carbon Accounting Financials is growing, enhancing transparency. Future implications include regulatory requirements, a shift towards low-carbon investments, increased transparency, customer preference for eco-friendly banks, and new business opportunities.

Carbon accounting in banks context

Numerous banks have publicly announced their intentions to reduce financed emissions under the goals of the Paris Agreement. Moreover, the Net-Zero Banking Alliance (NZBA) membership increased from 43 to 122 banks, representing 40 percent of global banking assets, in just over a year. Joining the NZBA requires a commitment to transition their lending and investment portfolios' emissions to comply with a net-zero trajectory.

Moreover, many more banks have conducted internal evaluations of their financed emissions and are deliberating whether to establish a public target. Some are considering taking the necessary steps to assess and establish targets for their financed emissions. As stakeholder expectations increase, emerging regulatory requirements in several regions are set to transform the disclosure of financed emissions from voluntary to mandatory.

According to McKinsey, evaluating and establishing targets for financed emissions is highly complex, as it involves factors like sectoral discrepancies, regional variations, fluctuations in counterparties' plans, evolving industry norms, and a developing and swiftly advancing data landscape. Additionally, the measures banks take to achieve these objectives frequently generate tensions with other goals, such as boosting revenue growth in critical business areas and requiring changes to vital policies and procedures.

Furthermore, banks must balance their objective of lowering financed emissions with the simultaneous aim of funding reduced emissions. This balance often involves extending financing to responsible heavy emitters that require capital to decarbonize their operations. Achieving this delicate balance is critical, requiring banks to exercise discretion and caution when determining which projects to finance.

Disruptive impact

More financial institutions will likely step up to announce their public emission commitments. In 2022, HSBC announced its target to achieve a 34 percent decrease in absolute on-balance sheet financed emissions for the oil and gas industry by 2030. Additionally, a goal has been established to achieve a 75 percent reduction in financed emissions for the power and utilities sector by the same year.

In addition, banks will likely join many accountability organizations to increase transparency on where their investments go. For example, the Partnership for Carbon Accounting Financials is a worldwide system for financial institutions to determine and divulge the emissions associated with their lending and investment portfolios. In 2020, it welcomed Citi and the Bank of America as members. Morgan Stanley has already pledged support for this campaign, making it the first US-based global bank to do so.

More regulations and standards may crop up as the industry doubles down on its carbon reduction commitments. However, the complexities of financial services may slow down progress as banks continue to assess how to tread the fine balance between sustainability and revenue. For example, Reuters reported in March 2023 that there is a split among banks regarding calculating carbon emissions related to their capital markets operations. Some banks are unhappy with a suggestion that 100 percent of these emissions should be assigned to them rather than to the investors who purchase the financial instruments. An industry-wide approach to this issue was expected to be unveiled in late 2022. 

Implications of carbon accounting in banks

Wider implications of carbon accounting in banks may include: 

• Carbon accounting becoming a regulatory requirement, with governments imposing emissions limits or penalties for exceeding them. Banks that fail to comply could face legal, financial, and reputational consequences.
• Banks adjusting their lending and investment practices to favor low-carbon industries or projects.
• Increased transparency and accountability for banks, as they will need to disclose their emissions data and demonstrate their efforts to reduce them. 
• Banks increasingly turning to carbon offsetting as a means of achieving carbon neutrality.
• Banks adopting new technologies to track and measure their carbon emissions. This trend could have technological and labor implications, as banks may need to invest in new software or hire employees with expertise in carbon accounting.
• Customers preferring to do business with banks that have lower emissions or are actively working to reduce them. 
• Carbon accounting requiring international cooperation, as banks may need to track emissions from companies or projects in multiple countries. 
• New business opportunities for banks, such as offering carbon offsetting services or investing in low-carbon industries. This trend could help banks diversify their revenue streams and capitalize on emerging sustainability trends.

Questions to consider

• If you work in a bank, how is your company accounting for its financed emissions?
• What technologies might develop to help banks become more accountable for their emissions?