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What does acting on climate change mean for the finance industry?

Global Trends
6 Mins.

Sustainable economic development is key to achieving a positive, climate-friendly future. How can financial institutions foster a green economy and encourage climate-resilient policies to make a real, positive difference?

In 2021, the topic of climate change was ubiquitous. In February, the US officially rejoined the Paris Agreement. In August, the sixth IPCC assessment was shocking news. In October, the Nobel Prize in Physics 2021 was awarded to science trio Syukuro Manabe, Klaus Hasselmann, and Giorgio Parisi, for their research on global warming and the environment. It is clear that the enormous task of carbon emission reduction and limiting global temperature increases is a mission for every sector and every industry – we all can and must be involved in climate action and must all play a vital role in combating climate change.

Fueled by consumer demand for a green value proposition, the financial services sector is waking up to the need to act positively when it comes to corporate sustainability. In 2020, Blackrock CEO Larry Fink’s annual open letter to the world’s CEOs contained an urgent wake-up call: we must act now to remain under two degrees.1 The ECB has analyzed the costs of not transitioning to a more climate-friendly economic approach, and the negative financial impact that would result from such a refusal to transition.2

Ensuring financial stability and preparing for climate change

Financial institutions and policy-makers have a twofold responsibility. Firstly, they must avoid financial instability. Climate change poses a direct threat to the stability of global economies, and the government introduction of climate action policies alters the economies of entire industries. Christine Lagarde, president of the ECB, has acknowledged that initial costs of moving to a more climate-friendly approach are higher – but the long-term savings are immense: “While transition costs may be higher in the short term, they are much lower in the long run than the costs of unrestrained climate change. Indeed, physical risks are the most significant source of climate-related vulnerability. Without further climate risk policies, the most vulnerable 10% of banks may see a 30% increase in the average probability of default of their credit portfolios between now and 2050.”3

The second responsibility lies in climate-resilient policies: the finance industry needs to be ready for the negative effects on business and for customers as a result of climate change. Lowering financial risk provides a measure of financial stability.

 

Economic climate action measures

There are some positive examples in banking. In April 2021, Brazil’s central bank agreed to incorporate climate factors into financial services regulation.4  The members of the IFC-hosted Sustainable Banking Network have advanced policies to promote sustainable financial practices in their countries.5 The G20 Sustainable Finance Group has been reestablished as a working group to drive policy change.6 The EU Commission’s action plan on financing sustainable growth set out a comprehensive plan that connects finance with sustainability.7 And in a hopeful sign of things to come, the carbon-tracking app Doconomy, which has investment backing from Mastercard and Ålandsbanken, among others, raised $17 million in September 2021, in what is being billed as the largest climate fintech investment in Europe. This is more than greenwashing. Climate-positive policies have been considered and written to alter the finance industry and the business models are in place, but are they enough?

“While transition costs may be higher in the short term, they are much lower in the long run than the costs of unrestrained climate change“
Christine Lagarde
President of the European Central Bank

Climate finance: concrete measures to protect the environment

With climate change reports growing increasingly dire, it’s necessary that further measures are introduced to bring systemic change:

  • Long-term policy frameworks are essential – early action provides trust, and higher levels of certainty for investors.
  • Transparency and disclosure will also foster transformation: the mandatory recording of climate-related statistics from financial institutions will help push for improvements. At present, the availability of comparable and consistent data in this area is limited, meaning it’s impossible to calculate exact losses. For asset managers, increased transparency could help make decisions and investments more climate-oriented.
  • The support of climate-positive technology: climate tech startups are abundant and can aid in unlocking major investment opportunities.8
  • Increased digitalization in banking: data-driven technologies increase transparency, and big data can integrate environmental risks into climate-risk-management policies.

The topic of sustainable finance has become more prevalent, but the industry needs to do much more to make sustainable, climate-friendly, climate-resilient practices a reality. Collective action is needed: a joint effort to increase transparency, to invest in a low-carbon economy and pro-climate products, and to adopt long-term financial climate policies that focus on the future and curate trust. Activist and environmental journalist Bill McKibben believes there is good news: “Renewable energy is 90% cheaper than it was a decade ago – it’s the cheapest power on earth, which means there isn’t a technological or financial obstacle to transition. And there’s an ever bigger movement demanding change!”

  1. Larry Fink’s 2021 letter to CEOs, Blackrock, 2021

  2. Christine Lagarde: Climate change and central banks – analysing, advising and acting, BIS, 2021

  3. Christine Lagarde: Climate change and central banks – analysing, advising and acting, BIS, 2021

  4. Brazil’s banks to incorporate climate change risks into stress tests, Reuters, 2021

  5. Sustainable Banking and Finance Network, IFC, 2021

  6. G20 Sustainable Finance Group, G20, 2021

  7. Renewed sustainable finance strategy and implementation of the action plan on financing sustainable growth, European Commission, 2018

  8. The State of Climate Tech 2020, PwC, 2020

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