Net zero demands a new sustainable operating model for banks

We are at a pivotal moment for humanity: to prevent climate change having a devastating impact on our planet, we must limit global warming to 1.5°C above pre-industrial levels by 2050 and cut emissions by half within a decade.

Banks can be at the heart of this change. They have powerful opportunities to grow their businesses by financing the transition to a more sustainable world and drive decarbonisation across sectors. In parallel, they must identify and reduce the climate-related risks they face themselves.

But banks can’t go it alone. To act on these risks and opportunities, they must work closely with governments, civil society, and corporate clients to embed sustainable business practices and facilitate reductions in emissions. Meanwhile, they’ll need to adapt their own businesses to align with net zero. There are five key dimensions where banks need to evolve their operating models.

Corporate culture

To manage climate risk effectively and commit to sustainable growth by setting Net Zero targets, banks must undergo a significant cultural pivot. This change must be owned and driven by the board. This is easier said than done due to uncertainties around policy developments as well as the technological advancements required to scale up the transition. The landscape is constantly shifting, as policies around Net Zero continue to evolve, and green technologies are advancing.

First and foremost, banks’ leaders need to understand the impact of climate risk and opportunities in the near term, as well as for what lies ahead. They must also realise that committing to net zero is fundamental to their growth strategy. This can deliver sustainable returns to shareholders while supporting the transition to a low-carbon economy.

After all, moving to net zero requires a new economic paradigm. It’s not just the C-suite and board that need to realign their focus. Change must cascade down the organisational structure of the company. Banks should create the right internal incentives to prioritise green deals and projects. This will require rewiring of internal frameworks across corporate planning and risk appetite.

Invest in hiring and training

Until recently businesses have not been run or managed through the lens of climate or with carbon as a constraint. As a result, many executives and decision makers may not have sufficient experience or expertise. They will need training and the right support to navigate new challenges in the face of volatility, and adapt to new key performance indicators, scenario-based planning and risk appetites.

Enshrining this new perspective at board level is just the start. Banks must also enhance their client relationships to ensure that both they and their counterparties are on mutually supportive net zero trajectories. Banks should ensure that their clients are committed to emission reductions to limit global warming to 1.5°C. Furthermore, counterparties need to be supported by banks that realise the difficulties and pitfalls of the transition to net zero, and that are willing to partner with them to reach climate goals.

Such a shift can only be achieved if banks’ relationship managers, risk and finance teams truly understand how climate risk will impact each client’s sector. As client relationships evolve, banks may face difficult decisions with respect to high-emitting clients that are not committed to transitioning at the rate required, despite receiving additional support.

Data quality and availability

To empower the board to steer their business on a sustainable net zero course and partner with clients to reduce emissions, banks must embrace data-driven decision-making and embed new key performance indicators and risk-appetite metrics. This requires information from a broader range of sources.

This new data landscape is daunting. Standards, regulations, and disclosures are evolving rapidly, and a one-size-fits-all data solution is unlikely to emerge in the short term. Banks should be increasingly transparent about the emissions being financed through their portfolio, and the targets they have set to reduce them–including any deviations from standards/guidelines or limitations in their approaches.

However, data quality remains a perennial weakness, and extending the current data architecture to include climate-related metrics will further add to the pressure. Moreover, banks will need to work with trusted providers of climate-related data, and leverage this to calculate their own risk exposure and collateral impact. This will be facilitated by the development of a common data taxonomy and shared principles.

Overall, the emergence of climate related disclosures is pivotal because it enables external stakeholders to compare and benchmark each bank’s progress towards net zero. This will empower investors, governments, and civil society to monitor which institutions are doing a better job of protecting the planet by enabling the net zero economy.

Engage with the broader ecosystem

Financial institution should not work in isolation from industry alliances, investors, and NGOs. They will need to influence policymakers, introducing measures to support net zero. For instance, they should help shape standards around data and reporting, and encourage policymakers to introduce incentives and subsidies to accelerate decarbonisation of different sectors. The move to net zero should become an engagement platform for dialogue with external bodies like governments, civil society, and international organisations (such as the United Nations, European Union or World Bank).

The partnership between the financial institutions and their clients needs to be at the heart of any strategy. Institutions should support their clients to make robust climate pledges and assess their alignment to 1.5°C pathway. This means they need to establish the right frameworks to assess the credibility of clients’ transition plans, encompassing a range of factors, which includes a number of considerations, such as whether the target is well-defined and measurable, whether executives are incentivised to meet the target, and whether this is backed up by sufficient investment, to call out a few.

Portfolio strategy

Firms must re-evaluate their portfolios in light of climate risk and manage them accordingly. They need to understand the level of portfolio steering that they will need to do, over and above their clients’ transition trajectories, in order to align to a 1.5°C base target. It will be important to create sustainable portfolios with returns and risks managed in line with net zero targets.

In the case of banks, there will be opportunities to support these initiatives by providing ringfenced transition financing and developing a suite of financial products to meet their clients' transition needs.

The way forward

This list may look daunting at first, but it should be viewed as a list of opportunities for growth. A new operating model aligned to net zero will help banks boost profitability and better manage risk, at the same time helping the world economy decarbonise and build a better future for our planet.

To find out more about how we can help you, please contact Anindita Pal and Guillaume Nerzic