Report: Fossil fuel bank lending could torpedo capital markets

Rules governing lending to fossil fuel-intensive companies need tightening to protect investors and the financial stability of capital markets, a report has warned.

In its report, Breaking the Climate Finance Doom Loop, the Finance Watch lobbying group said action taken by regulators to date had been unable to break the “doom loop” where “fossil fuel finance enables climate change,” threatening financial stability.

Thierry Philipponnat, one of the EU’s technical sustainability experts and author of the report, warned investors that climate change will start to exert “a destabilising effect on the financial system” unless further steps are taken to tighten lending criteria to fossil fuel companies.

In a stark warning, Philipponnat wrote that “financial instability will hurt banks’ and financial institutions’ accounts and, in all likelihood, threaten the very viability of many.”

The report comes several weeks after investors filed a landmark shareholder resolution to Barclays over its financing of fossil fuel intensive companies.

Back in January, more than 100 shareholders and institutional investors, including the Brunel Pension Partnership and LGPS Central, put forward a proposal to force Barclays to phase out its financing of fossil fuel companies.

This week, Finance Watch said that regulators already have the understanding and the tools needed to intervene immediately, but that their actions to date had mainly focused on transparency measures and stress tests, despite calls from central bankers – and investors - for more decisive and immediate action.

This latest report concluded that the most suitable tool was prudential measures targeted at banks with assets at risk of being stranded and that contribute to climate-related macro-prudential risk.

It proposed setting banks’ prudential risk weights at 150% for existing fossil fuel exposures, consistent with the approach taken in Article 128 of the EU’s Capital Requirements Regulation 2, and at 1,250% for new fossil fuel exposures.

The organisation also called for the risk weight measures it advocates to be adopted at a global level, as EU banks only account for 11 of the 35 biggest banking lenders to the fossil fuel industry.

It cited the Rain Forest Action Network Banking on Climate Change – Fossil Fuel Report 2020, which investigated 35 large international banking institutions and found that, over the four years since the Paris agreement, they had funnelled together $2.7trn of funding to the fossil fuel industry.

Finance Watch said that its recommendations to target the problem between climate change and financial stability were “far less radical and much cheaper” than the actions taken by governments and organisations in response to the Covid-19 crisis.