“Solutions exist to force banks off fossil fuels”

Fossil fuel financing by banks is a major concern for banking regulators. Many assets associated with the fossil fuel industry will need to be abandoned before the end of their economic life (“stranded assets”) to ensure the transition to a carbon neutral economy. This will come at a huge cost to financial institutions.

Assessing and managing these new financial risks is now a priority for prudential supervisors around the world and the G20 must accelerate this movement. To avoid the repetition of a scenario à la Lehman Brothers, it is urgent to withdraw this sword of Damocles that threatens taxpayers and slows down the transition.

Undervalued risk assets

In a recent study, the NGO Finance Watch estimates that the 60 largest banks in the world are exposed to risks of about 1,350 billion dollars linked to the presence of fossil assets on their balance sheets. As the risks associated with these assets are not factored into banks’ capital requirements, the entire world economy is once again put at risk.

The most effective remedy would be the adoption of a measure covered by Pillar 1 of the Basel III international rules, currently under consideration by the EU and Canadian legislators, namely the application of a sectoral risk weighting of 150% of bank exposures towards fossil assets. In other words, banks should increase their capital in proportion to their exposure to the fossil fuel industry.

An increase in the cost of financing that would not hinder the transition

Banking federations are fighting against this measure which would reduce the profitability of their fossil operations. They argue that the corresponding increase in equity would have the effect of drying up their ability to finance the ecological transition and that Europe’s energy security depends on this bank financing.

But under the current circumstances of high energy prices and windfall profits for the fossil fuel industry, an increase in the cost of financing would be manageable. And the measure would have no impact on the financing of the rest of the economy: the capital increase required by this measure could be achieved in a few months of maintaining bank profits (6.5 for France according to Finance Watch estimates).

The backdrop of rapidly rising interest rates and thus bank profits will further reduce this figure. After the 2008 financial crisis, banks had to mobilize a much larger volume of additional capital than that, and they managed it in eighteen to twenty-four months, without reducing their loans or their total assets. Taking into account the volume and maturities of banks’ current fossil assets, supervisors will be able to define an appropriate enforcement period to avoid any disruption of current lending.

Increase the resilience of banks

This fairly cheap measure would increase the resilience of banks to the effects of climate change by avoiding the blockage related to the difficulty of modeling the climate risk by banking models. This would reduce the length of time in which climate-related financial risks can accumulate, and thus the risks of a “disorderly transition”.

The G20 must urgently push the global supervisory authorities (Financial Stability Board, Basel Committee on Banking Supervision) to direct their work in this direction while the work of the COP27 is yet another reminder of the existential nature of the climate crisis. Europe also has a unique opportunity to play its part with the ongoing review of the Capital Requirements Regulation, currently on the table in the European Parliament and the Council of the EU. The time for inertia is over and we know what to do: there’s no more time to lose…

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