Climate change is the most pressing challenge of our century, acknowledged by the scientific community and proven by the impact, and increasing prevalence, of catastrophic and extreme environmental phenomena.
According to the Sixth Assessment Report by the Intergovernmental Panel on Climate Change (IPCC), the global carbon budget for limiting global warming to 1.5ºC above pre-industrial levels by 2100, equal to only nine years at today’s current production rates.
The current decade is the last opportunity to reduce global emissions and stabilize the global temperature at 1.5ºC, reaching net zero in the early 2050s. Today, the consequences of climate change are an increasing threat to the global economy; that’s why businesses and organizations must focus their efforts on sustainable development, strategies, and solutions.
According to the Swiss Re Institute’s stress-test analysis, “If no mitigating action is taken, global temperatures could rise by more than three °C, and the world economy could shrink by 18% in the next 30 years.” The analysis reveals that economies in Asia would receive the most damage; China could lose nearly 24% of its GDP, the US, nearly 10%, and Europe, almost 11%.
All industries play a part in preventing climate change, including the financial services industry. Sustainable finance, defined as “investment decisions that consider the environmental, social, and governance (ESG) factors of an economic activity or project,” is now imperative for all organizations.
Banks are the drivers of the transformation towards a climate-resilient financial system since they are the main actors leading the transition to a greener economy. Banking regulators and financial markets will affect how banks develop and implement climate-related strategies.
A path toward financial sustainability
Banks must take action by strategically disrupting the status quo, embedding a sustainable vision, reinventing their lending processes, and underwriting capital markets.
It’s through sustainable finance that banks will secure the economic viability of the business landscape and open the door to multiple opportunities. For example, greener counterparties entail a lower long-term credit risk. Green bond issuers grant access to better economic conditions than traditional issuers (known as the greenium effect) by becoming an essential input for market growth.
Furthermore, sustainable finance captures investors’ appetite for ESG-aligned assets, offering banks the opportunity to increase the engagement of their stakeholders and lower their reputational risk. Lastly, in many geographies (e.g., the European Union), banks must comply with new regulatory requirements concerning ESG.
Fundamental changes to consider for achieving a sustainable financial transformation
Embracing an additional risk in banking means reshaping the firm’s internal structure, including implementing an active supervisory board involved in environmental decisions. However, the bank’s strategy must add ESG considerations in the management of their portfolios (Risk Appetite Framework) and its annual objectives (commercial, risk, and financial planning), including the five following principles for ESG integration:
- Greening the portfolio: decarbonize through strategies that transition “brown” customers to green ones.
- Aligning the model to the bank’s framework: have the management model adapted to a customized framework, ensuring an “organic” and bottom-up integration.
- Integration in the future of banking: align sustainability management with the automation and industrialization objectives.
- Applying key technologies: an efficient and robust model based on extensive data, artificial intelligence technology, and agile transformation.
- Open sustainability: helps customers manage their risks and measure them.
The transformation requirements are dependent on new data sources: banks need to obtain new information that is traditionally unavailable or not captured within their systems, e.g., the CO2e emissions of their counterparts.
For carbon-intensive sectors, specific sectoral policies should be set and made public, giving details on the deployment of the bank’s strategy. These publications are a crucial part of communicating to the market. Thus, they should include measurable and meaningful goals.
Institutions and regulators are aware of the lack of information, but there are high expectations for incremental improvements. In this regard, financial institutions would benefit from leveraging available data providers and developing in-house AI capabilities to exploit new data.
Joining forces with other banks (through cross-national initiatives) would help level the playing field. On the other hand, adding advanced analytics to their sustainable strategy will help them face multiple challenges. The underlying differences between various business sectors make a one-size-fits-all solution impossible. Additionally, the considerable heterogeneity in maturity across geographies and the size of companies.
A clear strategic guide is needed to avoid wasting time and resources. Transitioning towards a climate-resilient financial system requires climate and industry experts on board, as new roles are emerging in the financial industry. For example, environmental risk analysts must embed climate considerations into the underwriting risk process as they align the new production with environmental goals; this is the only way to steer the current portfolio.
Banks must recruit climate professionals to bridge the gap between academic research, guidance from international organizations, and alliances (such as the Carbon Disclosure Project, the Network for Greening the Financial System, and the Task-force on Climate-related Financial Disclosures). This includes real-life company processes, providing climate-specific knowledge and expert judgment required for defining the ESG strategy, new business models, and measuring climate-related risks.
Additionally, the need to process and manage ubiquitous data implies that data analysts must be actively involved in defining, governing, and exploiting this information. Training all employees in matters of Sustainability to understand and adequately manage climate-related risks is necessary.
We will discover how to reach a successful re-adaptation towards a sustainable transition and what strategy to follow in Part 2 of this blog post.
For more information on how your business can stay ahead in finance, consult Globant’s Bluecap Future Finance Studio.
[1] AR6 by IPCC.
[2] CRO forum (2019), Insurability and Resilience in a Changing Climate.
[3] E.g., ECB (July 2021), Climate-related risk and financial stability: https://www.ecb.europa.eu/pub/pdf/other/ecb.climateriskfinancialstability202107~87822fae81.en.pdf
