Financial Sector Risks Can Hinder Transition to Green Economy

According to HSE and MGIMO economists, increased financial sector risks in developed countries may be associated with a higher carbon footprint in banks' loan portfolios. This is likely due to the fact that in response to an unstable economic situation, banks tend to issue more loans to companies that have a detrimental impact on the environment. Although this might yield short-term profits for the banks, such trends hinder humanity's progress towards achieving a green economy. The paper has been published in Environmental Science and Pollution Research.

Humanity is concerned about the rising temperatures on Earth. According to experts, one of the primary causes of warming is human activity that releases greenhouse gases into the atmosphere. Such gases accumulate, creating a greenhouse effect, which results in a rise in global temperatures. Greenhouse gases include more than just carbon dioxide, but CO₂ constitutes the largest portion of emissions, accounting for approximately 72%. All other emissions, like those of methane, are measured in terms of carbon dioxide equivalent.

The Paris Agreement adopted in 2015 stipulates that the increase in the global average temperature should be limited to well below 2°C above pre-industrial levels, and preferably to 1.5°C by the end of the 21st century. To attain this objective, it is essential to decrease global anthropogenic emissions by 40–60% from the 1990 baseline. The treaty was adopted by 175 countries worldwide, including Russia.

The concept of the carbon footprint is used as a measure of emissions, allowing for an assessment of the total greenhouse gas emissions generated directly and indirectly by an activity, a company, or the life cycle of a product over time. Reducing the carbon footprint has gained significance in the business world, as a strong environmental rating enhances the investment appeal of companies and fosters consumer endorsement and popularity.

The carbon footprint can also be calculated for financial institutions. In particular, the Carbon Footprint of Bank Loans (CFBL) is a country-level indicator, constructed as the average of CO₂ emissions from each sector weighted by the sectoral share of outstanding domestic loans from banks. 

For instance, as of the end of 2018, the highest CFBL was documented in Kazakhstan, amounting to 1205.1 tons of CO₂ per one million US dollars. This indicates that the weighted average level of carbon dioxide emissions into the atmosphere from all companies that received loans from domestic banks in Kazakhstan stood at 1205.1 tons per 1 million US dollars of loans issued.

Our goal was to examine whether there exists a correlation between financial risks and environmental performance. To do this, we needed to identify suitable indicators for environmental well-being. One such indicator is the Carbon Footprint of Bank Loans published by the International Monetary Fund.

Maria Shchepeleva
Co-author of the paper, Assistant Professor, HSE Faculty of Economic Sciences

HSE researchers examined the CFBL data for 37 countries from 2010 to 2018, as published by the IMF, and juxtaposed this data with a series of bank performance indicators, including concentration (the proportion of assets held by the five largest banks in each country), profitability, and financial risk.

The study discovered that bank risk indicators were correlated with the CFBL, whereas concentration and profitability had virtually no impact on it. Furthermore, it was revealed that systemic risk within the banking sector raised the CFBL in developed countries, although no such correlation was identified for developing and emerging economies.

The stable development of the financial sector can influence the pace of transition towards a low-carbon economy. The findings of our study highlight the importance of closely monitoring financial sector risks, as they may be associated with an increase in the CFBL.

Maria Shchepeleva
Co-author of the paper, Assistant Professor, HSE Faculty of Economic Sciences

IQ

October 09, 2023