As the global financial sector increasingly sets its own voluntary decarbonisation goals, banks are under greater scrutiny from investors to reduce emissions linked to the companies and projects that they fund.
Banks’ efforts to reduce financed emissions are shaped by a combination of internal strategies and external dependencies. While many institutions have committed to net-zero targets, their ability to meet them depends on factors beyond their control, including the availability and quality of emissions data, the effectiveness of customers’ transition plans, and the pace and direction of national decarbonisation policies.
Progress will not be linear. Banks may even see temporary increases in financed emissions because of short-term lending decisions or strategic investments in high-emitting sectors undergoing transition.
Emissions data
Moody’s Ratings analysis finds that one of the most significant hurdles banks face is the lack of high-quality, granular emissions data. This is particularly problematic for smaller companies and in sectors where emissions are difficult to quantify.
Banks typically rely on a mix of company-reported data, third-party estimates and sector-level proxies. However, these sources vary in reliability and consistency. Scope 3 emissions – those that occur across a company’s value chain – are especially hard to measure given their complexity and the lack of standardised reporting practices. This data gap not only hampers accurate emissions tracking but also increases the risk of banks having to revise their reported figures, potentially undermining stakeholder confidence.
Banks use two main types of emissions reduction targets: absolute and intensity-based. Absolute targets require a reduction in total emissions, often necessitating divestment or significant customer decarbonisation. These are more common in fossil-fuel sectors – particularly thermal coal, oil and gas, and power generation – which have received early attention from banks.
Many banks have set absolute reduction targets for these sectors, with some committing to phase out exposure to thermal coal entirely by 2030 or 2040. This supports banks’ credit strength by reducing their exposure to those borrowers that are most exposed to carbon transition risk. The other type of emissions reduction target is an intensity-based target, which measures emissions relative to output, allowing banks to maintain or even grow their exposure to sectors that are becoming less carbon-intensive.
Governance frameworks
To meet these targets, banks employ both active and passive portfolio management strategies. Active strategies involve adjusting the client mix to increase the number of lower-emission companies, while passive strategies rely on sector-wide decarbonisation trends. The latter approach is less certain to help meet banks’ targets, as it assumes uniform progress across all companies in a sector – an assumption that may not hold true in practice.
Robust governance frameworks are instrumental for banks to stay on track with their emissions commitments. Leading financial institutions have four key governance features: the appointment of a chief sustainability officer or a dedicated risk function, executive and board-level oversight committees, comprehensive carbon transition assessment frameworks and the integration of these assessments into financing decisions.
In our view, these frameworks not only support accountability but also mitigate reputational risks if targets are missed. In regions such as the European Union, regulatory developments are reinforcing the importance of governance. New legislation will require banks to incorporate sustainability-related risks into their capital planning and internal processes, aligning regulatory expectations with net-zero ambitions.
While many banks are still far from achieving their interim targets, Moody’s expects that more significant progress will become evident as 2030 approaches. Investment in data infrastructure, enhanced governance and alignment with regulatory frameworks will define headway in this area. Banks will navigate a delicate balance between supporting customers in their transitions and meeting their own emissions reduction goals.
Frank Mirenzi, vice president at Moody’s Investors Service.
This article featured in the most recent edition of the SPI Journal.
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