Can banks save the world? The case of Bank of America
Will the banking sector seize the opportunity to regain the trust of society?
My grandparents used to tell me of times when they entered their house through the roof as the entrance door couldn`t be opened due to the huge amounts of snow that accumulated overnight. It is not the case anymore as each decade since 1850 has been successively warmer than any preceding 10 year period. There is irrefutable evidence that we, humans, in our pursuit to maximize individual profits have forgotten about the externality costs produced – in particular global warming, – a cost that ultimately will have to be borne by us [1].
There are few industries as susceptible to climate change as the Banking industry is as a category that plays an integral role in funding all sectors of the economy. At the same time, this industry has the incredible capacity to leverage its scale and resources to help us transition from a high carbon to a low carbon economy. The International Energy Agency estimates that in order to meet the recent COP21 agreement pledges to cut carbon emissions and limit temperature increase to 1.5°C , the world economy would need to invest about $6 trillion / year over the next 15 years [2] – [3]. Although an impressive amount, it pales compared to the $65 trillion in assets the top 50 banks manage [4].
Bank of America (“BoA”) is one of the above 50 banks and over the past few years has embarked on a constructive path towards fighting climate change. The challenges BoA faces and the way these are addressed can be looked at from two major perspectives: risks and opportunities.
Risks. Climate change poses physical, regulatory, systemic and reputational risks over a significant part of BoA`s balance sheet, with the most affected portfolios in the agriculture, beverage, energy and infrastructure businesses. As global warming makes it more difficult to grow crops, raise animals, and catch fish, the companies BoA finances in this sector will show increased probabilities of default. The increased scarcity of water negatively impacts the credit worthiness of companies in the beverage industry. The higher likelihood of extreme weather events, such as hurricanes, affects the infrastructure and real estate portfolios [5]. Global consensus on climate change has led to the development of various policies meant to tackle this problem. The ratification of the COP21 agreement by the US will eventually result in regulations requiring inefficient coal powered plants to be phased-out by a specific date. According to the International Energy Agency, should the greenhouse emission goals be met, only one third of the established fossil fuel reserves would be used. All of the above cases will result in losses for the bank as assets will be either be stranded or companies will default.
Although part of the regulatory and reputational risk is mitigated through BoA`s coal, paper and forest policies which restrict the types of assets that the bank can finance or advise on, I believe much more needs to be done on this matter [6]. From a governance level, BoA should incorporate climate change in its rating and loss given default models, stress testing at overall bank level instead of individual projects, repricing of the loans and service, its risk management committee deliberations, and alignment of bankers` compensation with long term risks.
Business and Social Opportunities. Climate change is offering great business opportunities. In this respect BoA has done a great job by pledging to increase the company’s environmental business initiative from $50 billion (announced in 2013) to $125B in low-carbon and other sustainable business by 2025. To date the bank has delivered $53B since 2007 with $14.5B in 2015 alone [7]. In 2015, BoA was the biggest green bond underwriter in 2015 ($4.57B) in a $41B market with proceeds used to finance investments in climate change abatement or adaption projects. In 2016, BoA announced the expansion of the Catalytic Finance Initiative, growing it to a $10 billion commitment toward high-impact sustainable investments [8]-[9]. Over the past years, BoA has also gradually built its renewable portfolio, now several times that of its coal mining one. I find the bank has done great work in terms of economic and social opportunities, the latter exemplified by the co-signing of the White House American Business Act on Climate pledge.
Banks play an integral role in financing the economy and thus society has a large stake in the industry’s successful adaptation to climate change. This presents both an immense opportunity and a huge responsibility for the banking sector to get actively involved in combating climate change and to gain back the trust of society.
I hope that banks will help ensure my stories about snow I tell to my grandchildren will be the same as those they tell their grandkids. [781 words]
[1] NASA – Global Climate Change (www.climate.nasa.gov/effects)
[2] Boston Common Asset Management – Are Banks Prepared for Climate Change, 2015
[3] International Energy Agency – World Energy Outlook, 2015
[4] CDP – Tracking progress on corporate climate progress, 2016
[5] – Global Finance Magazine – https://www.gfmag.com/magazine/november-2015/biggest-global-banks-2015
[6] US Environmental Protection Agency – Climate Change Impacts (https://www.epa.gov/climate-impacts)
[7] Bank of America Corporation – Environmental governance and policies, 2015
[8] Bank of America Corporation – Annual Report, 2015
[9] Bank of America Corporation – Business Standards Report and Environmental, Social and Governance Addendum, 2015
This is a great post, Eugeniu– thank you. Banks are not often thought of as large contributors to global climate-change and sustainability but it is clear they have a huge role to play. BoA seems to have struck a nice compromise between the pursuance of profit for their shareholders and the encouragement of greener, more sustainable practices. While doing your research did you come across any other banks that appear to be doing anything close to this in terms of ensuring sustainable practices? A quick google search showed that in 2012 Goldman Sachs “established a target to finance and invest $40 billion in clean energy globally over the following decade. Just over four years later, [they] achieved this initial goal. In November 2015, [they] increased our existing target to $150 billion by 2025” (GS, 2016). Do you feel that these claims are realistic or merely clever accounting?
I liked you approach that Banks can address the climate problem, especially because I think banks can have great power of influence due to its nature of the business. First, It can leverage its professional knowledge for building funds for creating social impact, just as you mentioned about the biggest green bond underwriting. Second, it naturally has huge scale and tight relationship with other huge corporations. In that sense, I thought your approach was very interesting! Good job. Eugeniu!
Thank you for your comments and question Graham. You touch upon two very important topics: first, whether there is a clear initiative across the entire banking sector to work towards combating global warming and two, whether banks just hide behind these big numbers.
To answer your question, as far as I know, there is no strong initiative at the banking community level. However, there is an emerging trend in the banking industry to move towards business opportunities that help society switch to a low carbon economy. In order to gauge the extent to which the banks are doing so, there are indexes like DJSI (Dow Jones Sustainability Index) – which simply gauge how much banks are invested into making our economies greener. The real question to me here is, however, how much are banks (and their shareholders) ready to sacrifice in terms of profits / opportunity costs to support the transformation of the economy.
Very interesting and thought-provoking post, Eugeniu! I think your choice of a bank is particularly interesting because of the massive impact a bank can have on the direction and allocation of resources in the economy both today and in the future. I completely agree that banks have an enormous role to play. For starters, as you note, banks have great credit exposure to businesses that are negatively impacted by climate change. So, it is simply good business practice to recognize and account for these risks when underwriting. For these reasons, I really like your idea about incorporating some sort of climate change or environmental criteria in the credit underwriting process. Perhaps it is not binary, but at the very least there could be a scale that directly links to the rate or terms of a particular financing. Additionally, I never thought about but I really enjoyed thinking about the angle you propose – banks have suffered greatly in terms of reputation and it will likely take a generation to repair, rightly or wrongly, some of the damage banks have done from the public’s perspective. By getting ahead of and tackling such an important, large-scale, and highly impactful issue as climate change, I think banks can begin to regain some of the eroded confidence the public has in them. It is both good and good business from many perspectives.
cjt111242, thank you for your comments. I totally agree that the incorporation of climate change & environmental criteria should not lead just to a binary outcome of doing or not doing business but should rather be ultimately reflected in the loan price, which if too high, will simply result in high carbon businesses becoming unattractive.
I really enjoyed your post, Eugeiu. Banks do have unparalleled reach across the economy through the breadth of their financing activities and could use this to significantly bolster actions to combat climate change. While I appreciate Bank of America’s (and other’s) efforts to ramp up their investments in more sustainable energy sources, I think this should be accompanied by a reduction in fossil fuel-related investments. Bank of America is among many banks that have come out with limits on their coal-related investments specifically, but they could increase their impact by applying the same reductions to other similarly harmful energy sources like deep-sea drilling.
http://www.ibtimes.com/big-banks-betting-against-climate-change-policies-spending-billions-fossil-fuel-2381971
Thank you for your comments amals. I definitely agree that for BoA, and the banking industry in general, there is a long way to go before they make a real impact on the economy / society. At the same time, we have to bear in mind that these are entities owned by shareholders who want their companies maximize the profits in both short and long term. So finding the real balance between lower short term and long term sustainable profitability will indeed be the challenge.
Great post that has made me think about Bank of America in a whole new light. I would not have thought about banks as an important force in changing the direction of global warming. In this case however they are not simply doing it out of the goodness of their heats but out of a need to protect businesses on their balance sheet which are directly impacted by climate change and emissions regulations.
While I agree that banks have an enormous amount of power to shift the scales in the right direction, I am unsure that they will stop investing in lucrative businesses that involve fossil fuels all together. Ultimately I still see banks providing loans to businesses which have the least risk. However I am still hopeful as I have seen many different banks pursue a number of green initiatives seen below. http://www.wsj.com/articles/SB121433267845200539
Also I think Banks have a great amount of power to change consumer habits. For example a bank could provide more attractive leasing/loan terms on a hybrid vehicle compared to its standard non-hybrid equivalent.
Really great post, Eugenio! You made a really compelling case of why there are genuine synergies between the smart business and environmental sustainability. In particular, I found your assessment of the correlation between default rates and unsustainable business practices quite compelling conceptually. I would have loved to see more of a quantitative argument around this: are there data that shows that unsustainable (not environmentally friendly) business practices are correlated with higher default rates? I would imagine that these data would be hard to obtain, but it could strengthen your argument.
I agree with your proposal that BoA integrate climate change into its riskiness and default models; however, I wonder if the more appropriate business-specific metric would be a variable that indicates the effect of climate change on a business. For example, if a business is not sensitive to climate change, then the climate change metric wouldn’t affect the model. Conversely, if climate change is directly related to the business model (correlation = 1), then the metric would drastically affect the model.
Overall, this was a very compelling read — thanks for sharing your insights!
Just to play devil’s advocate, how much of the financing do you think is due to BAML wanting to change the market versus the market changing on its own and BAML trying to capitalize on the opportunity? I know this might be a slightly cynical point of view but I used to work on the investment banking side of BAML and a lot of the decisions are profit driven. While the bank does take reputation into consideration, a Managing Director cannot choose to turn down projects just because they are not beneficial to the environment (i.e. not take on a debt raise for an oil company) if it is making the firm money. However, while I think that the banking industry is fairly reactionary, you bring up some great points around factors the banks need to start considering when doing analysis. The other point that you didn’t mention, that I do think BAML and other firms have control over, is what they do with their real estate. Banks are huge land owners and BAML in particular has led the charge with its sustainable HQ on One Bryant Park (http://www.durst.org/properties/one-bryant-park). Hopefully its conservation efforts for its own buildings will inspire competitors to follow suit!
I liked you approach that Banks can address the climate problem, especially because I think banks can have great power of influence due to its nature of the business. First, It can leverage its professional knowledge for building funds for creating social impact, just as you mentioned about the biggest green bond underwriting. Second, it naturally has huge scale and tight relationship with other huge corporations. In that sense, I thought your approach was very interesting! Good job. Eugeniu!
Great post, Eugeniu! As a former regulator, I’m of course intrigued by your discussion of the robustness of BoA’s balance sheet to climate change risks. Stress testing for these risks seems like an interesting idea. Do you think loans and other assets should be given some sort of climate score (or one for susceptibility to regulatory changes, and one for susceptibility to actual environmental changes), and then they could test various levels of environmental regulation and climate change? My only fear is that every asset would likely have fairly idiosyncratic environmental risks associated with it, and thus it would be pretty difficult to model how exactly climate changes would affect the default likelihood. Regardless, I think it’s a really cool idea and something they’re going to have to start considering… Thanks!