Climate Responsibility in Banking Series: Bank Types & Their Fossil Fuel Investments (Chapter 2)

In episode two of Bank.Green’s series, Katherine explores financial institutions’ lending practices—from community banks to global players—highlighting their impact on fossil fuels and the renewable transition. Learn why climate-friendly lending matters by watching our video or read on for more!

Different types of financial institutions

Anoushka: So, in this episode we're going to look at how banks lend to different institutions. And first of all, I'd love to know a little bit more about what the different types of institutions are, and how do they differ? What do the major players look like? 

Katherine: Yeah, wonderful question. Banking and credit institutions sit on a really wide spectrum, right? So you have on one end of the spectrum your traditional community banks, your credit unions. This is how banking used to be done in good old days when you used to know your banker, right? All the way, on the other side of the spectrum, we have these big international giants like Citi and HSBC, and then you have all sorts of different institutions in between those two ends of the spectrum.

Credit unions

Katherine: So if you look at credit unions first, they tend to be non-profit entities. Their operating model is to lend to their members, who in most cases are individuals. Those credit unions who only deal with individuals will naturally not fund fossil fuel companies, right? Because they only do business with retail customers. Some may also serve as small and medium-sized companies but again, your large fossil fuel company, your Chevron, will not be a credit union member. These institutions, they're relatively small. They don't have the capital required to finance fossil fuel extraction or construction of pipelines or petrochemical plants. They're also – just moving away from fossil fuels for a second – they also tend to have fairly good values. They promote the wellbeing of communities.They reinvest in their communities. They create local jobs, so they tend to score highly in metrics such as social impact metrics.

Mid-sized banks

Katherine: And then in the middle we have mid-sized banks, right? They could be privately owned or they could be public companies. Again, most will not finance the fossil fuel industry, because they just don't have enough capital. Saying that, certainly in the U.S., because large banks have in the past been under so much spotlight and pressure for many years about their banking practices, we're starting to see these mid-size banks getting into this space of supporting the fossil fuel industry. And one way they can do that is through what is known as syndicated arrangements when they come together as a consortium and pool the funds, and then fund projects that way.

Big banks

Katherine: And then on the other side of the spectrum, we have these giant banks, these international public companies that do most of the lending to the fossil fuel sector across all stages of the fossil fuel extraction, production, and distribution process. So yeah, that's the spectrum; really wide. We have lots of different players with different characteristics, different amounts of capital available and different operating models. And when we rate them using our proprietary methodology at Bank.Green, we try and put them on the same level playing field whilst also taking into account these differences between them. 

What are examples of climate-friendly lending versus harmful lending?

Anoushka: Great. Thank you for that. And I guess my next question leads us into different types of lending. What are the most climate friendly types of lending versus the most harmful types of lending, and how do they look and how do they differ? 

Harmful lending

Katherine: Let's start with the harmful side of the equation and, first, I just want to acknowledge that there are lots and lots of different harmful activities that banks finance, right? So it's not just fossil fuels. It's deforestation, for example. It's unsustainable agriculture practices. And of course we're very conscious of these activities, but at Bank.Green, we're really focused on the energy transition. Because if you look at the breakdown of emissions, which is what's really causing the climate crisis, it's really the greenhouse gas emissions from the burning fossil fuels. That is by far the biggest slice of the emissions. So let's take a look at the most harmful activities.

And I think it's useful to first of all, discuss – what does the fossil fuel supply chain actually look like? So the first stage in that process is exploration. Exploration of new reserves; fossil fuel companies obtain licenses to extract fossil fuels then proceed to actually doing extraction, processing; for oil, this would be refining, and this is known as upstream activities. Then we have transportation of these raw materials through the pipeline. It's both transportation, but also construction of pipelines and treatment of these products. So they could be turned into products that ultimate consumers could buy. And these are midstream activities. And then we have onward distribution through like petrol or gas stations or utilities delivering gas to our homes. And these are downstream activities. And the reason it's important for us to break this down is because all of these stages have a different carbon intensity, different amounts of emissions associated with these different types of activities and therefore also different capital needs. So upstream activities such as extraction and processing are by far the most carbon intensive, but also most expensive, right? And also the most egregious one is what we and the industry has termed as expansion. So that's build-out of new infrastructure, not just continuing to support existing infrastructure already in place, but actually funding new oil fields, for example. And in our methodology at Bank.Green, we are hyper-focused on this activity of expansion and banks and financial institutions that finance new exploration and expansion activities automatically get the worst and lowest rating. On the other side of the spectrum, we don't judge like your small mom and pop gas station chain as harshly as extracting fossil fuels. Although, of course, these types of organisations and companies, they also need to be part of the solution. But we are less focused and concerned about downstream activities. Really the bulk of the problem is on the upstream side of the equation. 

Beneficial lending

Katherine: And then turning to the beneficial side of the equation. Again, that's a spectrum. So we have banks that just do not fund fossil fuels, there's a bank in the U.K. called charity Bank, and that's all they do is they fund charities, right? There's just no possibility of them ever funding fossil fuels. But then they don't necessarily do anything else. So they passively do not fund fossil fuels. Now there are others, particularly those that only deal with individuals, they may promote a range of green consumer products. So this would be things like preferential interest rates for the purchase of electric vehicles or special mortgages for energy efficient homes, acquisition of heat pumps. So there's that category of banks and then the gold standard: what we really need most banks to be doing at this point is lending to support the clean energy transition. So this would be commercial funding of utility scale renewable energy projects. This could be large solar farms or offshore wind farms, or on a small scale community solar energy, which also has community resilience benefits. So good examples of banks that fund these sort of large projects would be Climate First in the U.S. or Metro Bank in the U.K. So, that hopefully gives you a good overview of harmful on the one end, and highly beneficial on the other. 

Do some banks lend to both climate-friendly and harmful projects?

Anoushka: Cool. Thank you for that distinction. And on that note, I'd love to ask; are there banks that will lend both to good projects or institutions and to harmful projects and institutions? And what are their classic proportions? What will they tend to invest more in, and how will their portfolio look?

Katherine: Yes, There are plenty! Absolutely plenty of them that do both. And by the way, this is in our rating methodology the key metric that we use. At the cornerstone of our methodology is the ratio of renewable energy to fossil fuel lending. And this really depends on the size of the bank and actually when the bank was founded. 

Traditional banks

Those banks that have been around for a very long time, they have a lot of legacy lending, so maybe lending that goes back decades, legacy-lending to these fossil fuel companies.

Challenger banks

And then there are newer banks, you may have heard of like challenger banks. So the ones that were perhaps formed in the last decade or two, and they're responding to market pressures, but also consumer preferences. And it's really in their DNA to say 'we are just not going to participate in financing of harmful activities'. So they may well have a policy stating that we'll never lend to a range of these harmful industries. 

Banks & renewable energy to fossil fuel ratios

So for a large international bank that's been around for a long time, that ratio of renewable energy to fossil fuels, It could be like 4:1 or 2:1, or very commonly we see 1:1. So many of them fund as much by way of renewable energy as they do fossil fuels. Now, the challenge is though that in this one-to-one, on the fossil fuel side of the equation, a lot of it is new funding. So new projects we particularly dislike. So it's a really wide range. Now, what we need banks to be doing is to be increasing this ratio year on year. So, financing more renewable energy every year, and then financing less of fossil fuels, which means stopping any new expansion funding and not renewing them and not advancing any new funding. There are some international organisations such as the International Energy Agency, and then some data aggregators like Bloomberg and New Energy Finance, that publish benchmarks in terms of where we're now and where we need to be, and we know that the ratio of renewable energy to fossil fuel lending will need to be 4:1 by 2030. That's only five years away. When I said what we're seeing right now, for most large banks, it's 1:1. We need to be at 4:1 by 2030 and 10:1 by 2050. So there's a huge gap between where we're now, and where we need to be. And so again, in our methodology, we update it every year to up the level of ambition. And for 2025, we'll be expecting banks to be reaching the ratio of 2:1 because we're halfway between 2020 and 2030. So we're halfway towards that goal – 4:1, so we need banks to be achieving or getting close to that magic 2:1 ratio, which means twice the amount of lending to renewable energy to fossil fuels in order to receive a high rating from us. So hopefully that answers your question. 

See you next time!

Anoushka: Great, I think that's everything on my end. And I just want to thank you again for partaking in our educational series, Katherine, and for helping to explain to our viewers and our listeners and followers a little bit more about what we look for at Bank.Green and the distinguishers that we're trying to make between different types of lending institutions.

Katherine: Absolutely. See you next time. Thanks so much. Bye. Bye.