Banks

By imposing stricter capital requirements on fossil-fuel lending, governments and banking regulators can help to redirect a huge flow of funds to necessary climate-friendly projects. To those who claim that such a step would be too costly, the appropriate response is: “Compared to what?”

Many of us had hoped, perhaps naively, that global leaders gathering at the United Nations Climate Change Conference (COP26) in Glasgow last fall would significantly accelerate international and national efforts to slash greenhouse-gas emissions. It was not to be. Governments made some progress on methane emissions, deforestation, and the transition to electric vehicles. But other necessary action – above all, much more ambitious national pledges and plans – was postponed for another year.

The world cannot afford to waste any more time. On current trends, we have ten years before we exhaust our global carbon budget, reach interlinked points of no return, and crash through the 1.5º Celsius limit on global warming that governments and scientists warn is essential if our children and grandchildren are to have a livable future.

So, what is to be done? As a top priority, regulators and central banks should charge banks the real price for their polluting fossil-fuel portfolios, thereby permanently shifting incentives in favor of financing the green transition.

As the International Energy Agency has made abundantly clear, the exploitation and development of new oil and gas fields must stop. The IEA also warns that the world cannot build any new coal-fired power plants if it is to achieve net-zero emissions by 2050 and thus limit the increase in global temperature to a safe level.1

Tightening the capital requirements regarding the financing of fossil-fuel projects can help us meet this goal. Specifically, banks should be required to pay a “one-for-one” capital charge for any new fossil-fuel lending – as recently proposed by an international coalition of investors, academics, and civil-society groups. In addition, regulators should introduce a capital charge for existing fossil-fuel loans. This levy would depend on the nature of the activity being financed and would increase over time.

Changing banks’ investment incentives in this way would have immediate and rapid effects on their strategies and portfolios. In taking these simple but important steps, policymakers would align capital regulations with the growing international climate consensus among central banks, many of which now accept that their mandates contain an implicit requirement to act on climate change in order to help ensure financial stability.

The Basel Committee on Banking Supervision is currently considering how regulation should treat climate-change risks. These technocrats need to take the initiative and make climate polluters pay, thereby underscoring the absolute necessity of a halt to new fossil-fuel lending.

When bank lobbyists claim that such a step would be too costly, the appropriate response is: “Compared to what?” The reinsurer Swiss Re, which has some of the world’s best climate modelers, estimates that one-fifth of all countries face possible ecosystem collapse because of biodiversity loss and forecasts that failure to act on climate change could cost as much as 18% of global GDP by 2050. The European economy could contract by 10.5%. This cost – the multitrillion-dollar, hot-house reality of inaction and delay – is too great to bear.

In comparison, the problems of stranded assets and non-performing loans that will emerge as investors increasingly shun fossil fuels are far easier to manage. Most banks will be able to absorb these losses and reorient their loan books to speed the green transition. If some cannot make the shift because they are “all in” on fossil fuels, national regulators may need to establish “bad banks” to take the literally toxic assets off their books and restructure them. They have intervened in similar ways before, and they can do so again.