By Abhinav Jindal and Gireesh Shrimali
Summary
- The Paris Agreement urges making finance consistent with decarbonization goals. This entails estimating the carbon footprint of investments for setting science-based targets for decarbonization.
- For banks, financed emissions capture the indirect impact of their investments on environment. These are three to five times that of their combined Scope 1 and Scope 2 emissions.
- We estimated financed emissions of bank loans for India, at three levels – system level, bank group level and spatial level.
- Financed emissions show a rising trend with those for public sector banks plateaued, and for private sector banks doubled.
What are financed emissions?
Financed emissions, considered financial institutions (FI’s) Scope 3 emissions, are due to indirect impacts of financial services, investments, and lending. For banks, Category 15 Scope 3 emissions they capture the indirect impact of their investments and lending operations on environment. These emissions are most important from the point of view of outcomes of Paris agreement and in assessing climate induced financial risks. These emissions are on an average three to five times that of banks’ combined Scope 1 and Scope 2 emissions.
Why do financial institutions need to report financed emissions?
The role of financial institutions is critical since they provide significant funding for fossil fuels and other high-emissions industries. They can use the financed emissions information as a decision criterion for comparing companies while making investment choices. In addition to their own emissions, financial institutions need to quantify their financed emissions for integrating climate change risks into their core business of providing capital. However, assessing, managing, and setting targets for financed emissions is a complex and arduous task.
What are the challenges in reporting financed emissions?
The financial institutions Scope 3 emissions are the Scope 1 and 2 emissions of their investee companies. If all investee companies could report their Scope 1 & 2 emissions accurately, there would be little challenge for financial institutions in reporting their Scope 3 emissions. However, many companies don’t report emissions; and even for those that do, financial institutions lack trust on the data due to lack of transparency.
Lack of available standards is one of the biggest challenges in emissions data estimation, which increases subjectivity in reporting. This is related to the fact that there is no enforceable regulation on emissions data reporting, making it a voluntary exercise by financial institutions. In addition, in many instances, emissions data is incomplete or entirely missing. Specifically, when companies are presenting emission estimates with revenue-based numbers rather than asset specific numbers, there are significant uncertainties. It is for these reasons that financial institutions are trying hard to construct their own portfolio emissions.
WACI: Key metric for estimating financed emissions!
In a recent study, we estimated the aggregate financed emissions of Indian banks, using the Weighted Average Carbon Intensity (WACI) metric along with Environmentally Extended Input Output (EEIO) method. This measures the FI’s exposure to potential carbon-intensive companies, expressed in tCO2e/US$ million. The study reports WACI at 3 levels – system level, bank group level and spatial level.
We found that the financed emissions of Indian banks are of the order of 364 tCO2e/US$ million and have been rising over time. The top five climate vulnerable sectors identified using WACI included: (i) electricity, gas and water supply, (ii) transport, (iii) construction, (iv) basic metals, and (v) agriculture.
We also found that the Indian public sector banks exhibited the highest financed emissions of 304 tCO2e/US$ million. The private sector banks have seen a near doubling of financed emission – from 34.78 tCO2e/US$ million to 63.27 tCO2e/US$ million – driven by electricity, construction and transport sectors. The regional rural banks also account for financed emissions of 53 tCO2e/US$ million, due to their exposure to agriculture. Financed emissions of foreign banks are small – 14 tCO2e/US$ million.
We also found that the states accounting for the highest financed emissions included: Maharashtra, Delhi, Gujarat, Tamil Nadu, and Telangana. The analysis reveals the significance of tracking emissions at regional level, to be aware of the spatial aspects of financial emissions and corresponding transition risks.
What is the way forward?
Measuring and reporting financed emissions is important. In the absence of standards and regulation, banks rely on alliances, such as TCFD[1], GFANZ[2] and guidance such as the PCAF[3] and ISSB[4]. However, while these (e.g., PCAF) provide guidance, they cover only a limited set of asset classes, leaving other asset classes to a large degree of subjectivity.
There is significant value in reporting emissions with utmost transparency. While we have a long way to go to achieve perfect portfolio emission information, we cannot wait for that to happen and in the interim should improve reporting with all caveats, transparency, and assumptions. Our work is a preliminary assessment which may form basis for detailed investigation in future.
The overall objective would be to have a clearly defined and accepted baseline and estimating/reporting emissions to demonstrate reduction in emissions over time. Like financial reporting, third party options such as audit and assurance to help verify portfolio emissions data could be a best practice. This would provide an independent check thereby enhancing the quality and reliability of emissions data reporting.
About the Authors
Dr Abhinav Jindal is Associate Fellow, UK Center for Greening Finance & Investment.
Dr Gireesh Shrimali is Head of Transition Finance Research, Oxford Sustainable Finance Group.
[1] Task force on climate related financial disclosures (TCFD) strives to improve and increase reporting of climate-related financial information including risks and emissions by providing recommendations for disclosing clear, comparable and consistent information.
[2] Glasgow Financial Alliance for Net Zero (GFANZ) attempts to support financial institutions around methodologies, frameworks, and resources so as align their business activities to 1.5 degrees C pathways & NZ.
[3] Partnership for Carbon Accounting Financials
[4] In 2021, the International Financial Reporting Standards (IFRS) Foundation created International Sustainability Standards Board (ISSB) to meet the growing demand from investors for more useful reporting on climate and other ESG issues.