A rapid and chaotic energy transition would leave Europe’s biggest banks in financial peril comparable to the subprime crisis that U.S. lenders faced in 2008.
The 11 largest banks in the European Union, including BNP Paribas SA, Deutsche Bank AG and UniCredit SpA, have 532 billion euros ($648 billion) of investments and loans financing everything from extraction to transportation of fossil fuels, equivalent to 95% of their total common equity tier 1 capital (CET1), according to a report from think tank Rousseau Institute, Friends of the Earth France and fellow environmental nonprofit Reclaim Finance. A sudden drop in value of these “fossil-fuel assets” would deplete the banks’ capacity to absorb losses and might even leave them vulnerable to bankruptcy, the researchers said.
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While oil, gas and coal have fueled economic development since the industrial revolution, the level of carbon dioxide in the atmosphere is at record levels. Scientists have been warning that to avoid the most catastrophic impacts of climate change and reach the Paris Agreement’s goal of keeping global warming below 2 degrees Celsius, emissions must be cut in half by the end of this decade and reach net zero by 2050.
For banks, the risk is that assets tied to fossil fuels plummet in value, and possibly become illiquid, as business activities inconsistent with a 2 degrees-or-less world are abandoned. “The devaluation of fossil assets held by banks, following the inevitable ecological transition, could produce significant turbulence or even generate a new financial crisis,” according to the report. “The loss in value, whatever the speed, could put banks in a situation of bankruptcy.”
The potential for so-called stranded assets “mirrors the subprime mortgage crisis,” according to the report. If fossil-fuel assets were to lose 80% of their value, like what happened to the price of mortgage bonds securitizing low-quality homes during the last financial crisis, France’s Credit Agricole SA and Societe Generale SA wouldn’t have sufficient equity to cover their losses, and the equity of Germany’s Deutsche Bank AG and Commerzbank AG would be almost exhausted, the report says.
Fossil-fuel assets are equivalent to 131% of Credit Agricole’s CET1 capital, 109% for Deutsche Bank and 68% at Spain’s Banco Santander SA, according to the research. And that’s just “the tip of a gigantic iceberg” when it comes to banks’ potential exposure to transition risk from other industries.
All of Europe’s top-tier banks have committed to reach net-zero emissions across their operations and have ramped up their green investments. For the report’s authors, it isn’t enough. The banking sector is unlikely to move fast enough to decarbonize without action from governments and financial regulators, they said.
The report calls for regulations to prevent banks from making any new investment in coal, oil and gas; ending monetary policy that supports fossil fuels; developing national and Europe-wide regulations to force banks to align their operations with the objectives of the Paris Agreement; and creating a fossil-fuel bad bank to take stranded assets off their balance sheets.
“If they try to hide behind the development of a so-called sustainable finance that can easily turn to greenwashing, it won’t magically make fossil-fuel emissions, nor the financial risk they represent, disappear,’’ said Paul Schreiber, Campaigner at Reclaim Finance. “Strong financial regulation is a must to both enable the transition and consider climate risks.”