- July 2nd 2020 – Iggaak is a contributor to Green RWA’s first White Paper regarding Green Finance and the role of the banks in the low carbon transition.
How banks can save the planet!
White Paper Summary:
The authors of this White Paper believe that regulated capitalism through banks, can contribute to free the planet from the deadly threat created by an extremely fast and energy-thirsty growth over the last 150 years. On top of Green Bonds, banks, by analyzing their climate-related risks, will have to shift their banking book to optimise their long term capital charges, contributing to the 600 billion of green investments needed each year (on top of the $5,700 billions yearly infrastructure investments) for the next 15 year. This is the OECD estimate to reach the Paris agreement goal of limiting global warming well below 2.0 degrees by 2100.
This requires the harmonious support of regulators across the world to avoid the free-rider problem of GHG emissions but it is very interesting to note that thanks to the 2nd pillar of the Basle II, banks have the obligation of reviewing internal capital adequacy covering all risks. This means that even without the now active involvement of ECB and Bank of England, banks would be obligated to self-regulate and hold appropriate capital to cover climate-related risks. With 5 regions (China, USA, Europe, India, Russia) issuing close to 65% of CO2 the issue is significant, but with the support of a concentrated body of regulation in finance addressing climate change will be easier to tackle.
The mathematical model we are proposing in this Paper is an extension of the BIS existing model, including 2 factors which are classic in a climate-related risk approach: transition risk and physical risk. We consider a target scenario of IPCC to assess the physical risk and assume the regulator will force CO2 emissions reductions according to this scenario to assess transition risk. We are also proposing standard and advanced models under the EU taxonomy (CAPEX and OPEX alignment) to give banks the opportunity to integrate the value of green transformation of the financed corporate into the RWA.
We then lay down the foundations of an econometric approach of the loan demand and offer based on the marginal returns of the significant investments the transition requires. This will help assess the real cost of the transition and estimate how banks could shift their banking book over the next 10 years. A specific business case on a Retail Book is presented as part of the impacted balance sheet of any retail bank.With roughly 75% of corporate debt being loans, the economy in Europe predominantly intermediated (as opposed to USA). Hence, the shift of the banks balance sheets could have a massive impact on the financing of the transition.
This first publication aims to animate the debate on the banks role in the economy and it will be, as such completed, by a 2nd part in Q4 of 2020 where we want to gather real-life data and business cases from financial institutions, risk managers, climate experts and ESG data providers to an extended model including detailed portfolios by activities and geographies, transition matrices and correlation analyses (specifically GDP-CO2 correlation).
This is a call for collective intelligence and open collaboration which is fully supported and fostered by the Green RWA association.