making sense of financed emissions – Financial institution Underground

Lewis Holden

Over 95% of banks’ emissions are ‘financed emissions’. These are oblique emissions from households and companies who banks lend to or spend money on (banks’ asset exposures). Banks disclose these in step with rules designed to assist markets perceive their publicity to climate-related dangers and their influence on the local weather. However emissions disclosures fluctuate drastically between totally different banks with comparable enterprise fashions. Information high quality and availability is cited as the important thing purpose for this. On this publish, I reveal that variations in financed emissions estimates are defined by the extent of banking actions and asset exposures relatively than information high quality and availability. For instance, whether or not estimates seize a subset of mortgage exposures or wider banking actions resembling bond underwriting.

Evaluating financed emissions between banks could be difficult as a result of financed emissions scale with asset exposures. In Desk A, I summarise financed emissions from a subsample of globally systemically essential banks (G-SIBs) disclosures. For comparability, G-SIBs in Desk A are of comparable dimension.

Desk A: G-SIB financed emissions

Sources: G-SIBs’ climate-related disclosures and annual studies for monetary years ending 2024.

How can these G-SIBs, which all function globally with comparable enterprise fashions and asset exposures, report financed emissions an order of magnitude totally different from each other? Information high quality is normally cited as the important thing obstacle to accuracy and comparability. As an example, emissions disclosures point out ‘information high quality’ or ‘information hole’ a median of 10 instances. However is information actually the core problem?

The info argument goes like this. Households and companies which banks lend to and spend money on should disclose emissions earlier than banks can mixture these to calculate financed emissions. However the majority of banks’ asset exposures are households, shoppers and unlisted corporates that don’t disclose their emissions. As a result of disclosure necessities solely apply to massive, listed corporates. Giant, listed corporates predominantly entry finance by way of capital markets relatively than loans. Subsequently, banks must estimate the emissions of the households and companies who make up their asset exposures with a purpose to calculate financed emissions.

Is information high quality and availability the supply of variation?

I evaluate three totally different financed emissions estimates for a pattern of UK banks:

1. Reported in banks’ local weather disclosures.
2. My estimation mannequin, with proxy emissions information equipped by information supplier A.
3. My estimation mannequin, with proxy emissions information equipped by information supplier B.

The info suppliers I take advantage of are MSCI and LSEG. The estimate relating to every supplier has been anonymised. Broadly, my estimates seize banks’ company and mortgage mortgage exposures, as really useful by the Partnership for Carbon Accounting Financials (PCAF). PCAF is the trade normal steering for measuring financed emissions. Different exposures, resembling client finance, and different banking actions, resembling bond underwriting, are excluded.

Within the absence of granular mortgage degree information, my estimation mannequin assumes banks’ debtors could be proxied by a median. For instance, loans to the UK transport sector are proxied by the imply carbon depth for UK transport corporations which disclose emissions information. This mannequin has been developed by Financial institution employees and was utilized in The Financial institution of England’s climate-related monetary disclosure 2025.

Chart 1: Financed emissions disclosed by UK banks and estimated from my mannequin

Sources: Banks’ climate-related disclosures and annual studies, MSCI and LSEG.

Regardless of the vary of emissions information sources, proxies and aggregation strategies, estimates fall inside a spread of round 10%. This means the selection of emissions proxy information, and the way estimation fashions mixture this information, has a restricted influence on aggregated financed emissions estimates.

Variations in financed emissions on the particular person counterparty degree could also be extra divergent. For instance, the European Central Financial institution demonstrated that banks estimate a variety of emissions for a similar counterparty. My evaluation doesn’t dispute this. It merely demonstrates that when aggregated, financed emission estimates naturally converge in direction of the imply.

If information high quality and availability don’t drive variations, what does?

The important thing driver of variance in financed emissions estimates is just extent of enterprise actions and asset exposures which banks estimate emissions for. I describe this because the ‘boundary’ of the estimate.

In Chart 1, I intentionally chosen a subset of banks’ emissions reported on the idea of the identical boundary as my mannequin. This managed for the boundary impact and remoted the impact of knowledge high quality and availability.

Nonetheless, banks don’t persistently disclose financed emissions on the idea of the identical boundary. I establish three broad classes of boundary towards which emissions could be estimated:

1. Minimal boundary – an estimate for a subset of mortgage exposures. Typically these deemed excessive local weather danger, resembling to grease and gasoline firms.
2. PCAF boundary – an estimate protecting most mortgage exposures. Excludes some loans with unknown use of proceeds, resembling client finance.
3. All actions boundary – an estimate for all actions banks undertake and all asset exposures. Along with loans, this will likely embody ‘facilitated emissions’ – eg from bond underwriting, in addition to property managed on behalf of shoppers and never owned by the financial institution.

In Chart 2, as an alternative of evaluating estimates on the idea of the identical ‘PCAF’ boundary, I intentionally evaluate financed emissions estimates throughout boundaries for a similar pattern of UK banks as in Chart 1. As I’ve already decided that information high quality and availability has restricted influence in Chart 1, this comparability isolates the extent to which the boundary impacts estimates.

Chart 2: Affect of boundary on UK banks’ financed emissions estimates

Sources: Banks’ climate-related disclosures and annual studies, MSCI and LSEG.

Increasing the boundary from ‘Minimal’ to ‘PCAF’ (A) will increase the financed emissions estimate by nearly 50%. It’s because the ‘PCA’ boundary captures nearly all of mortgage guide emissions, whereas ‘Minimal’ boundary solely captures emissions related to a subset of excessive local weather danger loans. This enhance is materials as a result of whereas ‘excessive local weather danger’ loans are banks’ most carbon intensive, they symbolize a comparatively small proportion of whole loans. That is notably the case for UK banks whose largest exposures are residential mortgages.

Increasing the boundary from ‘PCAF’ to ‘All actions’ (B) will increase the financed emissions estimate by nearly one other 50%. It’s because the ‘All actions’ boundary captures emissions related to the broadest vary of banking actions, together with property underneath administration. This impact is pushed by the most important banks who undertake asset administration and capital markets actions. The impact is extra restricted for banks which don’t undertake these actions.

Decoding emissions metrics throughout boundaries

Regardless of the variation in estimates of financed emissions throughout boundaries, there is no such thing as a boundary which is superior. As an alternative, which boundary to depend on ought to depend upon the use case.

In Desk B, I suggest a easy framework for a way emissions metrics with totally different boundaries can proxy for 2 use circumstances – measuring climate-related monetary dangers and local weather influence. ‘Monetary dangers’ means, for instance, increased anticipated credit score losses on loans. ‘Local weather influence’ means banks’ contribution to local weather change, such because the financing of carbon intensive actions.

Desk B: Insights framework for financed emissions estimates

‘Minimal’ boundary estimates present restricted insights into banks’ monetary danger publicity and influence. It’s because they solely seize a subset of banks’ actions.

‘PCAF’ boundary estimates are essentially the most full proxy for assessing banks’ publicity to local weather monetary dangers. Mortgage exposures are the first transmission channel via which monetary dangers will come up. This has been demonstrated in supervisory stress checks such because the 2021 Local weather Biennial Exploratory State of affairs. Whereas different banking actions resembling underwriting and asset administration might expose banks to reputational and authorized dangers, the transmission of those dangers into monetary impacts is oblique.

‘All actions’ boundary estimates are essentially the most full proxy for local weather influence. Banks’ impacts on local weather change aren’t restricted to direct loans and investments. The ‘PCAF’ boundary doesn’t seize oblique impacts. For instance, in managing investments in fossil gas intensive firms, banks facilitate exercise which is able to contribute to carbon emissions and subsequently local weather impacts.

Conclusion

Variations in financed emissions estimates are attributable to variations within the estimate boundary, not information high quality. Transparency relating to estimate boundaries is subsequently important for interpretation of financed emissions metrics. No estimate boundary is finest, with every providing insights into totally different use circumstances. The ‘PCAF’ boundary finest proxies for banks’ publicity to monetary danger, whereas the ‘All actions’ boundary finest proxies for banks’ local weather influence. The PCAF boundary ought to subsequently be utilized by central banks in understanding local weather monetary dangers, in addition to in their very own monetary operations. Nonetheless, all emissions-based metrics are finally proxies. For monetary danger functions, they need to be supplemented with extra refined instruments resembling situation evaluation.

Lewis Holden works within the Financial institution’s Monetary Threat Administration Division.

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