Last week, shareholders of four large U.S. financial institutions — Bank of America, Citibank, Goldman Sachs and Wells Fargo — voted on shareholder resolutions aimed at pushing the banks to transition away from financing activities that contribute to the climate crisis. Similar proposals are upcoming at the annual meetings of JPMorgan Chase, Morgan Stanley and other large banks around the world.

And while resolutions considered last week failed to gain a majority vote, they underscored that the finance sector is increasingly under pressure — from shareholders, regulators, customers and the public — to account for their contributions to the climate crisis and how they are mitigating them.

At issue is something called “financed emissions,” greenhouse gases coming not from the banks’ operations but from the companies or projects in which a financial institution invests or lends money. For activists, including shareholder activists, the focus tends to be centered on fossil fuel projects — tar sands oil, Arctic oil and gas, fracking, coal mining and others — though that’s not entirely where the action is.

The world’s 60 largest banks provided $673 billion in financing to fossil fuel companies in 2022 alone, part of $5.5 trillion financed over the past seven years, according to data from a coalition of campaign groups organized by Rainforest Action Network. This, despite the net-zero climate commitments nearly every bank has made.

“Despite their net-zero language, banks’ policies could be doing more to align with global climate commitments,” wrote the report’s authors. Of the 60 banks profiled, 59 “do not have policies robust enough to meet the goal of keeping global warming below 1.5 degrees Celsius.”

Every sector has unique challenges related to climate mitigation, adaptation, measurement and reporting.

The topic is gaining traction beyond shareholders. In the United States, for example, a proposed Securities and Exchange Commission rule would, in part, require banks to disclose the risks of financial losses due to shifts in the economy away from fossil fuels and toward renewable energy, and to conduct and disclose analyses to assess how different climate change scenarios could impact their financial performance. There are similar rules pending or in place for banks in Hong Kong, Japan, New Zealand, the United Kingdom and the European Union. Last month, the European Central Bank published its third assessment of the progress European banks have made in disclosing climate and environmental risks. Those so-called “stress tests” are coming for U.S. banks.

So, how are banks addressing these pressures? I asked Valerie Smith, chief sustainability officer at Citi, the fourth-largest U.S. bank by assets and the 15th largest worldwide, to walk me through some of the considerations and challenges banks face when addressing their financed emissions, and how such exercises align with the actual business of banking. While the exact approach differs from bank to bank — a problem in terms of comparing one to another — the basic processes are similar. (For a much deeper dive, see this detailed comparison among four large U.S. banks.)

There’s no shortage of partnerships offering advice, frameworks and methodologies. For example, Citi is one of 129 members of the United Nations-convened Net Zero Banking Alliance, which helps banks in 41 countries measure and disclose their financed emissions using general though not prescriptive guidelines. The bank is also part of the Partnership for Carbon Accounting Financials (PCAF), a group of more than 200 financial institutions, which has developed its own approach to assessing and disclosing the greenhouse gas emissions associated with their loans and investments. Finally, there’s the Task Force on Climate-related Financial Disclosures, the reporting framework the bank used for its most recent annual emissions report, released in March.

A suite of metrics

In 2021, around the time Citi set its net-zero commitment, the bank “started to build our understanding of the framework that we should use,” Smith told me. “And also started to do the very hard work of calculating our baseline financed emissions.” That required developing “a whole suite of metrics that we publish for each sector, along with the targets,” she said.

This is no small task. Every sector — whether automotive, energy, steel, chemicals, aviation or consumer products — has unique challenges related to climate mitigation, adaptation, measurement and reporting. And many of the largest companies are in multiple sectors. General Motors, for example, is both an automobile manufacturer and financial services company, through its GM Financial subsidiary. Google is a media company that also makes hardware (Nest) and offers a digital payment system (Google Pay) and a high-speed internet and TV service (Google Fiber). Each requires its own data sets and calculations.

In using the PCAF guidelines, banks are free to adapt their own methodologies. For example, PCAF suggests that banks calculate only the carbon associated with the amount of money that a customer has drawn down from a line of credit or other lending facility. So, if a customer has accessed $50 million of a $100 million credit line, that’s the portion on which emissions calculations are based.

Citi decided to set a higher bar, calculating emissions based on the entire available credit line, regardless of how much a customer has actually borrowed. “That's what goes through the approvals process,” Smith explained. “And that's what we have available to the client should they need it.”

A detail, perhaps, but one example of how different banks’ calculations can differ in meaningful ways.

Ultimately, such differences may matter more to regulators and activists than to investors, whose interests lie more in financial risks and opportunities than in planetary or human impacts. “In terms of the operationalization of net zero, it is very much about business strategy because this is ultimately about realizing both the green economy opportunity and the transition finance opportunity,” Smith said.

“It is fundamentally not a sustainability initiative,” she continued. “It is a business strategy and business-led initiative.”

Of course, climate risk strategies differ from bank to bank, including how each bank is organized to address them. For Citi, “We organized some of our businesses to be oriented toward that transition,” Smith said. For example, she said, the bank created a team called Sustainability and Corporate Transitions that sits within its Banking and Capital Markets group and is focused on “investment banking opportunities for clients seeking to decarbonize.” In 2021, Citi established a Natural Resources and Clean Energy Transition Team, “a super group comprised of our energy banking team, our power team and our chemicals team.” These “super groups,” she said, reflect “the increasingly blurred lines between sectors.”

Looking forward and back

One big challenge banks encounter in calculating their financed emissions is the availability and quality of the data they get from their customers and other sources, and the challenges of using that data to make risk assessments.

When Citi considers the emissions associated with its clients, “We're looking both at the parent level and also the subsidiary level,” Smith explained. The bank uses data sets pulled from publicly reported information and makes estimates where there's no publicly reported information. “Any net-zero commitment is going to involve really large data sets, and it's going to involve communicating to your investors and other stakeholders about the data quality of what you're working with.”

Another challenge is determining which data are relevant to assessing risk. For the oil and gas sector, Citi looks at greenhouse gas reporting Scopes 1, 2 and 3. For the electricity sector, it looks only at Scope 1. “For each sector, we have tried to focus our net-zero work on the most material area.”

Most of this data will inevitably be a lagging indicator of a customer’s carbon footprint and potential risks, and the information can be as much as two years old, Smith explained. The data don’t necessarily factor in what might happen going forward — for example, the various technological developments that could accelerate a company’s decarbonization, the impacts of regulatory changes around the world, business model innovations or the unanticipated acceleration of disruptive or catastrophic weather events that could cripple company operations.

“Few banks have holistically quantified their physical risks by business or industry using forward-looking data and scenario-based modeling, as opposed to historical data,” according to a study published last month by Bain & Company.

“That's a gap that we certainly hope to see closed over time so that we're able to have a better sense of how our portfolio and how our clients are decarbonizing in real time,” Smith said.

All these calculations involve both art and science — that is, hard data combined with qualitative assessments about risks and opportunities.

“We're learning a lot from our clients about their transition opportunities,” Smith explained. “And there's an incredible amount of capacity-building that's happening internally. It's really the relationship managers for our clients that are on the front lines, speaking with our clients, identifying how we can support them in their transitions.”

It is “still an improving art and science,” she acknowledged. “But it's one where we're still learning.”

Thanks for reading. You can find my past articles here. Also, I invite you to follow me on Twitter and LinkedIn, subscribe to my Monday morning newsletter, GreenBuzz, from which this was reprinted, and listen to GreenBiz 350, my weekly podcast, co-hosted with Heather Clancy.