Net zero climate commitments by banks have the potential to direct trillions of dollars in capital and effectively transition the global economy to a low-carbon future. Notwithstanding some very visible pushback on ESG and climate-related policies, the trajectory to a low-emission economy is underway. And on the heels of the United Nations’ strengthened net zero standards announced at COP27, banks are facing considerable challenges in navigating this shift.

As banks look to move beyond commitments and begin to operationalize their climate goals, they will increasingly need to develop strategies that incorporate the following key elements:

  • Customized methodologies: Each bank is unique and needs to develop customized methodologies based on a differentiated portfolio mix of asset classes, sectors, geographies and clients.
  • Data management: While climate and emissions data are central to analysis, planning and execution, these are often hard to source, low quality and with substantive gaps, putting a premium on effective data sourcing and management.
  • Client engagement: Banks must increasingly engage with clients to help them baseline and decarbonize their operations, and integrate climate considerations and low carbon opportunities into commercial strategies.

Why have major US banks set net zero targets?

Stakeholder pressures, coupled with the climate imperative, have driven large banks to set net zero targets for financed emissions over the past two years. At the same time, emerging regulations like the Securities and Exchange Commission’s March 2022 proposed rule on climate risk disclosures are raising expectations for transparency in the market.

The Federal Reserve Board's recent announcement that six of the largest US banks will participate in a pilot climate scenario analysis exercise is also raising expectations for banks to manage their climate-related financial risks. Meanwhile, investors are putting banks on notice, with record numbers of shareholder resolutions on net zero and fossil fuel investments passing during the 2022 proxy season.

Recognizing the need for change across the real economy, JPMorgan Chase, Bank of America, Citigroup, Wells Fargo, Goldman Sachs, Morgan Stanley and others became signatories of the Net Zero Banking Alliance (NZBA) in 2021.  Signatories are expected to take several concrete steps to meet their promises to align their operational and financed emissions to pathways for net zero by 2050. Among these, banks are expected to set their first financed emissions targets within 18 months of becoming a signatory, and subsequently set targets for all or a majority of designated carbon-intensive sectors within the first 36 months, as data allows. Additionally, NZBA banks must publish their absolute GHG emissions and emissions intensity annually. ERM has been working with several major banks worldwide on target setting and portfolio emissions reductions.

While currently at an earlier stage in the process, and with smaller carbon footprints, regional banks are also facing stakeholder pressure to set targets and decarbonize their portfolios. They also need to prepare for emerging climate-related risk management and disclosure requirements, and can benefit from the learnings from the efforts of the major banks. With more limited in-house climate experts and other resources than major banks, regional banks will see greater need for partnerships and cost-effective solutions to address technical and operational needs. ERM sees ‘outsourcing’ and SaaS solutions (such as ERM's NetZero Compass) playing a greater role in this transition.

Building effective net zero strategies

To put these commitments into action, banks will need to advance strategies for expanding methodologies across additional sectors, managing data challenges, and engaging clients in the development of decarbonization strategies and climate-related commercial opportunities. ERM has experience for guiding the banking industry in each of these areas.

  • Customized methodologies: Financed emissions methodologies are the foundation for effective commercial strategies that align with net zero goals. They must be tailored to a wide range of sectors (including energy, power, automotive, agriculture, industrials, aviation and shipping) and asset cases (including corporate lending, syndicated loans and real estate). Effective methodologies require aligning metrics with a bank's specific portfolio and with the institution’s forward-looking strategy. While some banks have made clear decisions to rebalance their portfolios and reduce overall exposure to high-emitting industries, many are choosing to reduce their overall portfolio emissions by partnering with existing clients to support decarbonization of their operations and expanding their businesses into segments with low or negative emissions.
  • Data management: Data is the bedrock of target setting and execution of decarbonization strategies. Issues abound including poor data quality; cross-cutting standards; different uses and end-users; client readiness; differing proxies; data management systems; and integration with existing risk and IT technologies. Effective data sourcing and management is key to achieving net zero as it provides a clearer image of where the emissions are generated and targeting the opportunities to reduce them. An effective data management strategy can enable banks to analyze and develop complex data requirements to accurately forecast emissions reductions scenarios needed to inform key decisions. While ERM and other firms have developed solutions that will enable better and more accurate data quality and management, it is critical to rigorously identify and solidify the data requirements before making solution selection and design decisions.
  • Client engagement: Banks have an opportunity to rethink how they engage with clients, leverage their influence as lenders to advance decarbonization roadmaps, and strengthen relationships while advising and assisting with executing climate targets. Banks have many tools at their disposal. They can provide incentives through sustainability-linked products to borrowers who demonstrate progress on climate goals, and benchmark clients against their peers to identify emissions-reduction opportunities. Critically, they can provide analysis, advice and capital for the many significant emerging opportunities – including renewable energy, grid infrastructure, hydrogen, electric vehicles and critical minerals – that are set to grow rapidly throughout the course of the energy transition. Banks now need to develop these commercial strategies, organizational capabilities and client engagement models to capitalize on these opportunities.

There are many challenges for banks as they respond to the pressure to decarbonize financed emissions and seize new commercial opportunities. Banks must balance the competing expectations of shareholders, regulators and competitors and the many tensions between them; navigate the world of target setting in areas where this is still new; grapple with very different data requirements and build systems to manage and leverage data; rebalance their portfolios and engage with clients on decarbonization; and identify and build out capabilities to capitalize on a new set of opportunities that are emerging from the low carbon landscape. Change brings opportunity, and well-prepared institutions will be well-positioned to capitalize on them.

This article was authored by ERM experts Rob LaCount, Faisal Khan, John Fleming, Debasmita Sarkar, Anna Nikolova and Emily Willson.