Sophie Hong and Cary Di Lernia, authors of “Banking and Climate Risk: A Regulatory Crossroads” in the current issue of the Company and Securities Law Journal, Vol 39 No 4, cite the Fossil Fuel Finance Report 2022 for the above figure on capital mobilisation for fossil fuel industries.

“A significant driver of banks’ continual support can of course be attributed to the profit motive behind the lucrative fossil fuel industry,” say Hong and Di Lernia. The “deep ties” between those on bank boards, fossil fuel corporations, and political leaders have an effect too. Banks likely have an “ideological inclination” towards carbon-intensive industries, conclude the authors.

Yet in their influential and “pivotal” position as mobilisers of capital, resides the “huge potential” for banks to assist fast-tracking a low-carbon transition, by directing the flow of investment away from carbon-intensive activities towards those that are low-carbon and climate-resilient. It is in their own interests to do so, suggest the authors, as climate risks are “distinctly financial in nature given exposure to both physical and transition risks”.

The current prevailing policy framework for the banking system to address climate-related financial risks (CRFRs) advocates disclosure to reduce information gaps which prevent accurate pricing of CRFRs. For Hong and Di Lernia this is insufficient to effect the necessary low-carbon reorientation of banking activities. What is needed, they contend, includes macroprudential measures such as system-wide explicit limits on the volume of certain types of lending or borrowers.

But even this route of “forced” change may not alone suffice “to overcome the finance sector’s dominant logic of short-termism – where short-term gains compromise longer-term objectives”. Performance fees structures, quarterly results, incentive structures – all militate against banks adopting a prudent approach to addressing climate change through the pursuit of longer term, greener investment options. The authors suggest macroprudential regulation should be complemented by “a restructuring of the relationship between finance and society through an amplification of the role of the concept of social licence”; requiring banks to act in an “accountable and socially acceptable manner”.

Given the critical role social licence plays in protecting a financial institution’s reputation – and with “growing pressure from institutional investors and climate activists for an industry-wide paradigm shift towards generating long term returns for a sustainable planet” – maintaining a “robust” social licence points a way forward for banks, argue Hong and Di Lernia. It could be achieved by such measures, as: targeting remuneration away from a focus on short-term incentivisation and profit maximisation; tying social licence to a firm’s code of conduct and mission statement with mandated company-tailored social licence strategies; and having social licence boards to broaden the voices of diverse stakeholders including representatives from governments, employees, and local communities.

Together, tightened macroprudential regulation and social licence pressure, may help “foment the shift in consciousness necessary at the core of banking”, say Hong and Di Lernia. They add though, that “it will require a critical mass of managers, employees, shareholders, and other members of civil society to push and maintain such action from below”. The planet may in part depend on it.