Despite their central role in causing the global financial crisis, exactly 13 years ago this week, banks remain at the centre of the European economy.

They finance more than 90% of European small and medium-sized enterprises (SMEs) and approximately 80% of European corporates.

That means they also have a central role to play in today’s biggest crisis: the climate challenge.

It is not just their direct financing activities – in the energy sector alone the top 35 banks provided close to $3trn of funding in three years to 2019. But banks also have a critical multiplier effect on the rest of economy through their engagement with existing clients.

Engagement between bankers and clients tends to be longstanding and forward-looking and if they can import climate risk into these discussions and use environmental criteria to influence underwriting decisions and loan pricing, then they can drive the whole economy towards net zero by 2050.

Green bond market suggests banks are grasping the green nettle

Importantly, we are starting to see European banks rise to the climate challenge in the green bonds market, one of the most important mechanisms for redirecting institutional capital into the green economy.

Global green bond issuance continues to rise, having exceeded the $1trn mark on a cumulative basis with close to $300bn in 2020 alone. In Europe, banks have been one of the most active players in this growth, driven by a record $33bn of investment in the first half of 2021 alone.Banks have been issuing green bonds at a faster pace than European corporates, with banks’ green bonds accounting for 35% of the market, compared to non-green bonds accounting for 28% of the market.

This is part of a wider deployment of ‘net zero by 2050′ strategies by mainstream banks as demonstrated by the Net Zero Banking Alliance, a UN-backed initiative committing global banks with over $30trn in assets to align with keeping global warming to well below 2°C, and so catalysing a pipeline of green assets such as green bonds.

We estimate that the green bond market for European banks can easily reach €200bn or more in the next 24-36 months (compared to c€80bn currently), given the current pace of issuance.

Regulation is the catalyst to ramp up green financing

Banking-related regulation is locking in this trend. Since the 2007/08 global financial crisis, regulators’ track record in transforming the banking sector has been impressive, and with climate risk at the forefront of the regulatory agenda, the trend for the next decade(s) is clear, including likely measures to improve disclosure and introduce stress testing.

Climate stress tests are perhaps the biggest game changer as they will in time influence banks’ capital planning, most likely through either capital surcharges for ‘brown’ financing or capital add-ons for inadequate climate risk management.

This is already incentivising banks to ramp-up their green asset financing. For example, Banco Santander is looking to raise and facilitate €220bn of green financing over the next decade.

But we can’t rely solely on the banks

While the banks have a primary role in greening the economy, other finance players have an important part to play. It is vital that investors in green bonds engage to ensure high standards and avoid those without a genuine sustainability purpose. This requires in-depth analysis at the issuer, bond and project level.

We have clear criteria to determine which issuers and bonds are eligible for investment. At the issuer level, we conduct in-depth analysis of issuers’ ESG credentials. This is done using a proprietary scoring model, where laggards are excluded. A credible climate strategy with a net-zero commitment is a key part of this analysis.

At the bond level, we seek green bonds with strong governance and processes. The analysis is done using a proprietary model, based on the ICMA Green Bond Principles, enhanced by additional internal requirements. Specifically, we seek granular reporting from issuers, subject to third party verification. At the project level (use of proceeds), we assess whether there is meaningful positive environmental impact, using third-party quantitative data as well as our own analysis.

Given the urgency with which we must tackle climate change, green bonds from European banks have become a powerful instrument for investors to generate meaningful positive environmental impact. But it’s important that investors in these bonds are active owners that ensure, this time, the banks drive positive change in a crisis.

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