The imbalance between the demand for sustainable finance and the capital that lenders have available for it, along with a pressing need for harmonized reporting on climate risk from banks and their clients alike, are among the problems the banking sector must address to accelerate sustainability, according to Leonie Schreve, ING Groep NV's global head sustainable finance.

The banking sector is progressing faster than many companies they finance, as evidenced by the mismatch between the more than €4 trillion in capital that European banks have vowed to align with the Paris Agreement on climate change and the amount of suitable corporate lending available in the market in Europe, the CDP, formerly the Carbon Disclosure Project, said in a recent report. Banks, too, need better environmental, social and governance data from the market and to harmonize standards within the financial sector, industry observers said.

The changes necessary "to really accelerate sustainability" simply cannot be done "on your own, as a bank," the rest of the market needs to move in sync toward the same goals, Schreve told S&P Global Market Intelligence. If the bank wants to finance electrification in the automotive sector, for example, the sector itself must aim to expand electrification, otherwise "we have a problem because we can't do business," she said.

Less than 10% of European companies, weighted by their total outstanding loans, are aligning with the well-below 2 degrees C targets, while banks representing 95% of all corporate lending in Europe are aiming to achieve alignment, the CDP said.

Company-reported ESG data is also a big challenge for financiers. "ESG data is notoriously inconsistent, incomplete and frequently reliant on corporate voluntary disclosure. So even when financial institutions settle on an ESG strategy, data may be missing or inadequate to fulfill it," U.K.-based investment firm Octopus Ventures said in February.

ESG evaluation

Netherlands-based ING, which started reporting on its carbon footprint in 2005 and was carbon neutral by 2007, is aiming to get its peers and customers to join efforts to keep global warming well below the 2-degree Paris Agreement target via its so-called Terra approach.

Terra will allow ING to reach Paris climate accord alignment in its corporate loan book in a structured manner, S&P Global Ratings said in its recent ESG Evaluation report.

Ratings considers "ING's environmental policies, their scope of application, and the methodologies used to assess environmental risks" more advanced than average. The agency has an overall ESG profile score of 76 out of 100 for ING, which coupled with a positive preparedness factor of 7, brings the group's total ESG Evaluation to 83 out of 100.

The preparedness assessment adds a key forward-looking element to S&P Global Rating's evaluation and helps it go beyond the still "imperfect" ESG data available in the market, Bernard de Longevialle, global head of sustainable finance for S&P Global Ratings, said in an interview. The assessment is made after meetings with senior management, he said.

Moving together

Despite the COVID-19 pandemic, leading global banks have continued to embrace the ESG agenda, global auditing firm KPMG said in a recent report. The banks also seem to recognize "that this is an issue that requires industrywide ... collaboration and response," KPMG said. "A third of the largest banks globally have signed up to the Principles for Responsible Banking. Many are participating in regulatory discussions around taxonomy and green finance," it said.

Engaging other banks to use the same methodology will help standardize the sector's approach to steering credit portfolios toward Paris Agreement alignment and yield comparable results across lenders. Different banks report very different figures on greenhouse gas emissions' impact on transactions, for example, Schreve said.

"We cannot expect banks [to disclose] information about climate risk of their portfolios if our corporates, our clients, don't report," Antoni Ballabriga, global head of responsible business at Spain's Banco Bilbao Vizcaya Argentaria SA told Market Intelligence in an August 2020 interview.

Science-based climate benchmarks

ING's Terra approach is based, to a large extent, on the Paris Agreement Capital Transition Assessment, or PACTA, for Banks methodology, which the Dutch group co-created with global think tank 2˚ Investing Initiative, or 2DII, in 2018 to measure climate risk in the Dutch group's €700 billion corporate lending portfolio. However, the bank did not want to have an ING-only standard and together with 2DII made PACTA for Banks an open-source system so peers could join, Schreve said.

The methodology was the first of its kind in the market because it provided a standardized way for banks not only to assess the current Paris Agreement alignment of high-carbon sectors they lend to but to also gain insight into the transition plans of those sectors compared to the science-based climate benchmarks set for each, Schreve said.

Knowing how much clients plan to invest helps open a conversation about ways the bank can finance their transition to a sub-2-degree future or help them accelerate that transition, she said. The PACTA sector-by-sector analysis enables ING to not only assess "what needs to shift, but also how much and by when," the bank said in its description of the methodology.

BBVA, BNP Paribas SA, Société Générale SA and Standard Chartered PLC joined ING in laying the groundwork for the PACTA for Banks method and 17 leading global banks in total had tested it before its official launch by 2DII in September 2020.

In November 2020, ING published for the first time the Terra alignment of all nine of the high-greenhouse gas emission sectors in its portfolio, including power generation, fossil fuels, automotive, shipping, aviation, steel, cement, residential mortgages and commercial real estate.