How financial institutions can help transition to net zero

Climate change and greenhouse gas emissions have become a major negative externality of economic activity. In economic activity, particularly in industrial production, extensive use of fossil fuels releases significant amounts of carbon dioxide (CO₂) into the atmosphere. 

Globally, approximately 52 billion tons of  CO₂ equivalent emissions are released into the atmosphere each year due to fossil fuel use, as Bill Gates highlighted in his book "How to Avoid a Climate Disaster." Since the 1850s, there has been a substantial surge in greenhouse gas emissions resulting from burning fossil fuels, coinciding with a corresponding increase in global temperatures. 

Economic activities are intertwined with financial institutions, including venture capital firms, investment banks, commercial banks, non-bank financial institutions, insurance companies, etc. Hence, financial institutions wield significant influence in tackling climate change and managing the greenhouse gas emissions of the companies they invest in, as they serve as the primary source of capital for the growth of the industrial sector. Realising this, the 2015 Paris Climate Agreement emphasises financial institutions' vital role in actively combating climate change and reducing carbon emissions. 

Consequently, multiple global coalitions involving insurance and financial institutions have been established to attain net-zero emissions, one prominent example being The Glasgow Financial Alliance for Net Zero (GFANZ). The primary objectives of this alliance are to compel banks, insurers, and investors to reshape their business models, establish credible strategies for transitioning to a low-carbon, climate-resilient future, and subsequently put those plans into action.

On the other hand, climate change poses a substantial financial risk for financial institutions and insurance companies. Insurers and reinsurers face significant physical risks on their asset side. At the same time, liabilities increase due to insurance policies generating more frequent and severe claims due to climate change-induced losses than initially anticipated. Likewise, the credit risk associated with climate change has notably escalated for banks due to the heightened frequency of disasters and the gradual obsolescence of fossil fuel-based technologies.

Although climate change poses credit risks to financial institutions and insurance companies, it also presents a significant business opportunity. The transition of the world economy required to attain net-zero emissions by 2050 would be comprehensive and substantial, necessitating an annual average expenditure of $9.2 trillion on physical assets, which is $3.5 trillion more than the current level, as highlighted in a study conducted by McKinsey. Such a substantial sum can only be deployed with the backing of global financial institutions and the facilitative regulatory framework provided by international communities. 

In 2023, a projected sum of around $2.8 trillion is earmarked for global energy investments. Over $1.7 trillion is set aside for clean technologies, encompassing renewables, electric vehicles, nuclear power, grids, storage, low-emissions fuels, efficiency enhancements, etc. as per the latest World Energy Investment report by the International Energy Agency (IEA). The remaining portion, slightly exceeding $1 trillion, is allocated to coal, gas, and oil. Therefore, financial institutions must refrain from investing in fossil fuel-based energy to attain net-zero emissions by 2050.

Given the present socio-economic conditions of Bangladesh and its position as one of the countries with minimal carbon emissions, it may not be practical to cease financing fossil fuel-based projects entirely. Even some financial institutions of Bangladesh might have significant exposure to fossil fuel-based energy within their portfolios. 

In such instances, ensuring a secure exit strategy is paramount. Financial institutions should actively promote the transition of their investee companies toward low-carbon, environmentally friendly practices by offering transitional financing. New investments in fossil fuel-based energy should be avoided, while renewable and clean energy investments should be accelerated even more rapidly.

The consensus is clear that achieving the net-zero target demands substantial investment. Yet, the current inquiry pertains to how financial institutions can get this significant amount of money. 

As a financial instrument, Green bonds offer a viable solution for banks and financial institutions to raise the necessary funds for financing the transition towards a net zero economy. It gained widespread global popularity since the European Investment Bank's inaugural green bond issuance in 2007. 

The total green bond issuances have surpassed $2.334 trillion as of today. While the taxonomy of green bonds may vary, they primarily advance environment-friendly, low-carbon footprint initiatives. Green projects often demand longer-term financing, a significant advantage of green bonds in green transition financing. 

The Central Bank of Bangladesh has recently introduced a green bond policy for the banking industry. Consequently, financial institutions in Bangladesh can raise funds from the market by issuing bonds to support the net-zero transition. 

In such instances, regulatory bodies like Bangladesh Securities and Exchange Commission (BSEC) and Bangladesh Bank will ensure that the funds are channeled into projects that align with the green bond taxonomy, particularly those emphasising the net-zero objective, such as renewable energy. 

While the introduction of a green bond policy is indeed important, it alone may not be adequate to prompt financial institutions to issue green bonds. Removing other regulatory barriers is crucial to establishing an enabling environment. 

Global financial institutions must endorse and invest in Carbon Capture and Storage Technology (CCS) despite the financial risks involved. While numerous startups in this field may not be financially feasible yet, financial institutions should innovate and introduce novel financial products to bolster these technologies. 

In developing countries like Bangladesh, collaborative alliances between financial institutions should support innovative ideas and research and development (R&D) initiatives focused on renewable energy, Carbon Capture and Storage Technology, and other similar projects. Financial institutions can utilise funds from their Corporate Social Responsibility initiatives for support.

Karimul Tuhin is an environmental economist and green finance professional. Email address karimul100@gmail.com  

Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinions and views of The Business Standard.