Transparency and Ambition

The first theme, “Transparency and Ambition,” looks at how each bank measures and discloses its portfolio emissions and the targets banks have set to reduce emissions to net zero. “Portfolio emissions” include financed emissions (Scope 3 Category 15) and facilitated emissions (associated with off-balance sheet activities). This is at the core of a net-zero commitment: Portfolio emissions tied to financial activities constitute nearly 100% of a bank’s carbon footprint.

The level of transparency and ambition can be demonstrated by the immediacy of the institutions’ interim targets; their scope and scale in terms of sectors covered; the reduction being targeted; and validation by credible third parties such as the Science Based Targets initiative (SBTi)¹. Our tracker shows the starting point for each institution's volume of portfolio emissions, allowing stakeholders to track progress toward reduction goals and net zero over time.

Transparency and Ambition Takeaways

• Banks have made progress in setting emissions reduction targets and expanding the number of sectors covered, but more is needed. Banks often fall short in providing comprehensive coverage, which would include all material business activities and their associated emissions (financed and facilitated emissions) as well as material elements for emissions (such as value chain segments).
• A lack of transparency in target-setting makes it difficult to compare banks on equal footing. The level of transparency and quality in disclosures and methodologies behind banks’ emissions reduction targets is still not uniform, which prevents informed analysis and comparisons. Disclosure of assumptions and data related to targets in a clear, organized and structured manner enables stakeholders to better understand the composition of targets and assess quality and progress. Improved transparency can differentiate banks that have set robust targets from those with similar “headline” numbers but lower levels of quality.
• Targets are not yet driving emissions reductions at the necessary pace and scale. Most emissions reduction targets are not in line with limiting warming to 1.5 C. Banks should provide more explanation for why these gaps exist and how to close them. And, while some banks have reported early progress on emissions reductions, it is unclear whether these are based on real decarbonization or “paper decarbonization,” where emissions are reduced only “on paper” by limiting portfolio exposure.

• Few banks have integrated third-party validation into their commitments. Third-party validation can reassure various stakeholders of the quality and ambition of net-zero targets, yet this remains an uncommon practice among banks.

   

Emissions Reduction Targets

Emissions reduction targets are central to a bank’s net-zero commitment. Though banks generate some emissions from their own operations, their largest impact on the climate comes from the lending and financial services they provide to clients that operate in the real economy. (For example, a bank which finances a coal plant is partly responsible for the emissions it produces.) These indirect emissions — referred to as “financed emissions” by the Partnership for Carbon Accounting Financials (PCAF) — have been reported to make up over 99% of a financial institution’s total emissions.

Banks are also involved in capital markets activities such as underwriting, securitization and advisory services that are temporary by nature and considered off-balance sheet. Emissions related to these activities are categorized as “facilitated emissions” by PCAF and are also materially significant to banks’ total emissions.

A common practice used by banks is to set targets for high-emitting sectors (such as oil and gas and power generation) that contribute significantly to global greenhouse gas emissions. Some firms set targets by asset classes, such as corporate loan portfolios. Banks tracked in our tool have set different types of emissions reduction targets for a range of sectors and asset classes. Here, we look at the various targets banks have set in 11 different areas:

Banks decide whether their portfolio emissions will be disclosed and reduced on an “absolute” or “intensity” basis.

• Absolute emissions targets aim to reduce the total amount of emissions by a specified amount and are usually measured in metric tons of CO2. Absolute targets are often considered the most credible and should be prioritized for real-economy companies.
• Physical emissions intensity targets normalize emissions by comparing them with a unit of physical output (such as tons of CO2/megawatt-hour). These are also considered credible when they are set to converge with sector-specific decarbonization pathways.
• Economic emissions intensity targets normalize emissions to an economic unit (such as tons of CO2/enterprise value). These are more volatile to portfolio companies’ valuations and financial market conditions that may not be tied to real-world emissions reductions. They can be useful in certain contexts, but are often considered the least reliable out of the three types and should be used to complement, not replace, absolute and physical emissions intensity targets.

We also evaluated how ambitious banks’ emissions reduction targets are and found that, overall, they are not aligned with decarbonization pathways that would limit global warming to 1.5 C. The figures below compare banks’ emissions reduction targets by sector and contrast them against 1.5 C-aligned decarbonization pathways developed by the Transition Pathway Initiative (TPI), which are based on the IEA’s net-zero scenario.

Robust emission disclosures and reduction targets should incorporate the following elements:

• Focus on portfolio emissions (both financed and facilitated emissions).
• Specific targets for high-emitting sectors or asset classes.
• Disclose emissions on both absolute and physical intensity basis.
• Comprehensive coverage of the material aspects that drive emissions (such as value chain segments of each sector).

Financial institutions should disclose both absolute and physical emissions intensity targets because each type has its own merits and they complement one another. Complementary data such as financing values is also valuable to understand whether the drivers for emissions reductions or increases are related to financing activity or a portfolio company’s decarbonization.

Other aspects that are material when determining emissions and targets include: materially significant segments of the value chain within each sector; the specific emission types (CO2 or CO2-equivalent); calculation of lending exposure on an outstanding or committed basis; and the scopes of emissions from clients that are included in the net-zero targets. For a detailed discussion of these additional considerations, please see the technical note.

It is important to note that banks’ emissions may rise in the short term before falling in the long term. This can happen when banks provide transition finance to clients in hard-to-abate sectors that are still heavy emitters, such as oil and gas, but use the financing to implement new zero- and low-carbon technologies and processes that result in emissions reductions. Similarly, banks’ total emissions may rise when they are engaged in the managed phaseout of high-emitting assets, such as the early decommissioning of coal. In such instances, it is important to evaluate emissions in the context of real-world impact. Emissions reduction targets should ultimately lead to financing the physical capital investments needed to decarbonize the economy. They should not result in “paper decarbonization,” where banks simply reduce their exposure to emissions without supporting the transition in the real economy.

In other words, it is more beneficial for the global goal of reaching net zero that a bank’s financing results in the buildup of low-carbon assets (such as green steel) or the phaseout of high emitting assets (such as coal plants) than the bank just reducing its portfolio exposure by disposing its lending book.

The Science Based Targets Initiative (SBTi) is developing methodologies to incentivize banks to align their portfolios to support decarbonization in the real economy rather than merely reducing their exposure to emissions. Such targets on portfolio alignment can indicate the share of financing toward firms and activities transitioning toward net zero as well as those that are net zero-aligned. Other metrics for transition finance on expected emissions reduction have been suggested by UNEP-FI and are likely to be implemented as banks engage with transition finance.

Banks’ client compositions and geographies will also impact their ability to meet emissions reduction benchmarks. For example, Asia’s power generation relies heavily on high-emitting methods like coal, while lower-emitting sources have a higher share in the European and North American power grids. Banks that are mostly exposed to European and American power companies will therefore have a lower emissions-intensity profile and be closer to the benchmark. Additionally, banks may experience short-term volatility in their portfolio emissions due to external effects; for example, the travel disruption caused by the COVID-19 pandemic in 2020 resulted in higher emissions per passenger carried. The tight relationship between industry dynamics and portfolio emissions underscores why industries (and banks, by extension) will rely on policy support to close the gap and achieve sectoral decarbonization pathways.

Credit Exposure Covered by Emissions Reduction Targets

High-emitting sectors such as oil and gas, power generation and automotive face higher risks associated with the net-zero transition, as their business models and revenue streams are most likely to be affected by changes in policy, technology and consumer preference. Banks can be exposed to such risks through their clients in the industry. But they also have more leverage to engage with clients and provide financing that drives significant emissions reductions.

Here, we track banks’ credit exposure to these high-emitting sectors. Stakeholders can use this information to monitor how banks are managing their exposure to high-transition-risk sectors and visualize their coverage of targets for such sectors.

Banks that are setting targets for high-emitting sectors are more likely to be effectively managing their climate-related risks and their portfolio exposure to such sectors. Some banks disclose their level of exposure in the scope of their net-zero targets, which provides a more accurate representation of the relationship between targets and portfolio exposure. Disclosing this information indicates that banks understand how targets relate to their client relationships and balance sheets. The information provides insight on how much of a bank’s lending portfolio is aligned with the transition as well as any significant gaps in coverage, particularly concerning sectors that are material both in terms of emissions and credit exposure.

However, most banks disclose their credit exposures broadly by sector. This may not be fully in line with net-zero targets, such as when targets cover limited parts of the sector’s value chain. Additionally, some banks that have set targets by asset classes have disclosed the total amount of exposure in line with their targets but without a sectoral breakdown. 

Off-Balance Sheet Activities

Emissions related to off-balance sheet banking activities, such as underwriting or advisory services, are known as “facilitated emissions.” These activities account for a sizable portion of financing activities that contribute to real-world emissions: It is estimated that, since 2016, about half of fossil fuel financing from the top 60 banks by asset size was attributed to facilitation services like underwriting. However, facilitated emissions are often not included in disclosures or emissions reduction targets.

In the figure above, “aligned” banks include all off-balance sheet activities in at least one of their targets, “partially aligned” banks include some off-balance sheet activities, and “not aligned” banks do not include off-balance sheet activities or do not have targets.

The Partnership for Carbon Accounting Financials (PCAF) has developed guidelines to calculate facilitated emissions, and some banks have developed their own approach and included them in their targets. One key difference in approaches lies in the weighting factor used to calculate facilitated emissions, with PCAF suggesting a 33% factor while some banks use a more comprehensive 100% factor. PCAF’s guideline is focused on underwriting activities, and additional methodologies will be needed to account for other types of activities such as advisory services of mergers and acquisitions. Banks will be able to expand their coverage of off-balance sheet activities as methodologies are developed for more types of activities.

Validated Science-based Targets

In addition to setting emissions reduction targets, it is essential that banks clearly define and independently validate them. When they don’t, it is difficult for regulators, shareholders and consumers to evaluate the integrity of these targets and their alignment with net zero.

The Science Based Targets initiative (SBTi) — founded as a collaboration between CDP, World Resources Institute, the World Wide Fund for Nature (WWF) and the United Nations global Compact, and now incorporated as a charity — is one of the leading organizations that helps corporations, including financial institutions, set and validate targets. Several financial institutions, including banks, have completed their validation process, and others have committed to do so.

In the figure above, banks are “aligned” if their targets are validated by SBTi, “partially aligned” if they are committed to submit to SBTi for validation, and “not aligned” if they are neither committed nor validated.

While validation is an important step to ensure high-quality targets, it is not the only one. Extensive transparent reporting, robust oversight, continuous standard improvement, and implementation monitoring will be required to ensure banks are fully aligned with limiting warming to 1.5 C.