This article is adapted from an op-ed originally published in the Hindustan Times authored by Dr. Sidhant Pai, co-founder and Chief Science Officer at StepChange.
As governments, corporations and individuals across the globe begin to grapple with the realities of climate change, the world will increasingly look to financial institutions as gateways to a greener economy. Since these institutions serve as the de facto enablers of the production and consumption activities that drive greenhouse gas emissions, they are uniquely positioned to analyse, strategise and reduce the embodied carbon that pervades our economy. As the world begins the transition to a low-carbon economy, the financial sector will need to get up to speed on a long list of methods, standards and frameworks designed to mitigate and abate climate change. Of these new concepts, perhaps the most salient and nuanced is the notion of ‘financed emissions’.
Financed emissions refer to the greenhouse gas emissions that occur as the result of investments, loans and other forms of financing. Due to the highly financialised nature of modern economies, financed emissions are associated with almost every sector and industry, and span a wide variety of key asset classes (e.g., business loans, project finance, mortgages, vehicle loans, etc.). Estimating and attributing financed emissions is a complex exercise, with a lot of potential risks around double counting. It is, however, a crucial one nonetheless. Given the size of the Indian economy, a top-five bank can expect to have a financed emissions footprint in excess of 50 million tonnes of CO2e. To put that number into perspective, that’s more than the total emissions attributed to countries like Norway and Switzerland.
In addition to the importance of understanding financed emissions due to their sheer magnitude and influence on the economy, tackling this class of emissions is crucial for a number of other reasons. Climate change is poised to have a structural impact on our economy over the coming two decades, and financial institutions should expect to be exposed to both the physical risks associated with a warming globe (extreme weather, floods, droughts, etc.) as well as the transition risks associated with stranded assets in a carbon-sensitive economy (e.g. oil fields, petroleum products, etc.). Analysing and incorporating the risks associated with carbon-intensive sectors and asset classes will become a key component to informing portfolio management at financial institutions that are looking to future-proof their business models. Banks that are ahead of the curve in terms of their decarbonisation goals will also stand to gain access to cheaper sources of private, public and governmental capital, with ESG performance being linked to capital flows across the globe. In addition, customers both in India and abroad are increasingly demanding that corporations (including banks) take a serious stance on climate change. Catering to this increasingly influential and affluent client base will become an important strategic goal for many financial institutions.
Perhaps the most important reason to understand financed emissions, from a practical standpoint, is the regulatory pressure that banks will face from bodies like RBI and SEBI to disclose their climate-related portfolio exposures and risks. In order to comply with these increasingly stringent regulations, banks will need to invest in the tools, advisory services and in-house expertise required to understand their financed emissions and strategise opportunities to effectively decarbonise their portfolios without impacting their bottom line. Access to sophisticated methods and frameworks for calculating financed emissions and establishing science-based targets will thus become a strategic priority for large banks that are looking to limit climate-related risks and mitigate regulatory pressure.
Tackling financed emissions is by no means an easy task, but there are emerging best practices and science-based tools that can help banks and other financial institutions improve their measurement capabilities, set achievable targets, monitor progress, report results, and support their clients in their decarbonisation journey. The transition to a low-carbon economy will also drive all kinds of new business opportunities for innovation and collaboration. Financial institutions with their fingers on the pulse will adapt their portfolios in a manner that takes advantage of these systemic changes, reaping the economic benefits of the transition while supporting a more sustainable modern economy. By accounting for, and reducing their financed emissions footprint, banks and other financial institutions can position themselves to create long-term economic value for both themselves and their investors, particularly as climate risks become more central to real-world operations and corporate decision-making. StepChange is a climate-tech startup that helps companies and brands accelerate their sustainability journey and transition to NetZero. Learn how we may be able to help your organisation through our website or simply follow us on LinkedIn to stay tuned!
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