Banks need to wake up to the risks of lending to unsustainable industries
What is your money doing while it's sitting in your savings account? Is it locked into a safe in the bank basement, stacked in crisp bills? Is it sitting there, patiently waiting to be withdrawn and used for the annual family vacation, or the kids' college expenses?
Not really. A retail bank borrows your money, combines it with other deposits, and lends it back out to larger projects. It hopes to earn a greater return from its lending and financing projects than it promised to provide your deposits. Some of these are simple to see and understand, like the corner bakery expansion or your neighbour's mortgage. Others are so complex and convoluted that even finance professionals poorly understand them.
A bank's success or failure lies with correctly valuing assets and assessing risk within its lending portfolios. The housing bubble happened in part because banks overvalued assets, believing that home prices would continue to rise, even when economic indicators pointed elsewhere. They also misunderstood the inherent riskiness of their investments, believing them to be safer than they were.
Unfortunately, there are now signs that we're on the verge of another bubble. A carbon bubble.
This year, Boston Common Asset Management and other investors filed a shareholder resolution at PNC Financial, a Pittsburgh based retail bank and significant lender to mountain top removal, an extremely environmentally-intensive coal mining process. We also filed with JPMorgan Chase, the leading lender to coal utilities. We asked for information from both institutions about how they plan to manage climate risk, and their assessment of the ways in which their lending and financing contribute to global warming.
From a risk perspective, climate change brings looming regulation and legislative uncertainty. Climate disruption, meanwhile, puts any property or industry with a weather dependency at risk. Think ocean-front real estate, agriculture, forestry, tourism, anything in a flood zone or a water scarce region. Banks, which consider their loans according to risk tranches, need to be incorporating these new patterns into their models. Banks also face reputational risk, should their brand become associated with the financing of a highly environmentally damaging project.
In addition, investing in a coal dependent infrastructure continues a dependency on harmful technology, requires assumptions that there will be no shifts in consumer sentiment, and that current rates of greenhouse gas emissions will be allowed to continue. HSBC Global Research released a "Coal and Carbon, Stranded Assets: assessing the risk" report in June, 2012 which stated that "that carbon constraints post-2020 could impact DCF [discounted cash flow] valuations of coal assets by as much as 44%." If this is correct, the ability of coal and carbon dependent companies to generate the revenues required to service their debt may be called in to question.
We were able to withdraw our resolution at JPMorgan Chase because the company made progress on the issue. It has begun to develop a greenhouse gas management and assessment process and has committed to publish an environmental and social risk assessment policy.
However the conversations at PNC Financial have not been so successful and our resolution has remained on the ballot, to be voted on 23 April 2013. Given the climate crisis, we know that a business based on current emissions levels is unsustainable. As investors, we want to ensure that the PNC board and top management understand climate change as a financial issue and the implications it may have for their business.
However, the problem isn't just about climate risk impacting investor returns. Banks and other financial institutions contribute to climate change through their financed emissions, which are the greenhouse gas footprint of loans, investments, and other financial services. A bank's financed emissions can dwarf its other climate impacts and enable a significant amount of greenhouse gases that would not otherwise have been released.
It's clear that businesses based on current emissions levels are unsustainable. As investors and as citizens, we must "pop" the carbon bubble now. In doing so, we protect both our economy and our environment.
Meredith Benton is client portfolio and shareholder engagement manager at Boston Common Asset Management, an investment manager and a leader in global sustainability initiatives.