The backlash against green weightings

Banks get a lot of flak for not doing enough to mitigate climate risks

Almost everyone agrees that tougher capital requirements imposed after the financial crisis have made the system safer, essentially saving banks from themselves. Could they be used to save the planet, too?

One bank seems to think so.

In September, Natixis unveiled its green weighting factor (GWF) for allocating capital to loans based on their climate impact. Loans to heavily polluting borrowers will have their risk-weighted assets (RWAs) hiked by as much as 24%; the greenest loans see theirs cut in half.

While some support the idea, it has generated a fierce backlash from some banks and regulators. Critics say adjusting risk-weightings in this way defeats their very purpose, which is to ensure banks set aside sufficient capital to absorb losses. It could even be counter-productive – loading-up green companies with cheap debt only makes them riskier.

Others say Natixis has put the cart before the horse. While there is a growing consensus that the creditworthiness of borrowers will be affected by climate change, quantifying this risk is difficult. Existing climate risk models, such as those used by insurers, have a poor record of predicting losses and may be too crude to use in capital-setting. “Why should a green project get X% less RWA against it?” asks Hervé Duteil, chief sustainability officer for the Americas at BNP Paribas. “To be honest, it’s arbitrary.”

More sophisticated models are under development and some banks are already running them in parallel with regulatory capital models. The French Prudential Supervision and Resolution Authority is also working on draft models for measuring climate risks, which are expected to be released soon. 

Even if climate risks could be estimated with precision, it’s not clear that adjusting credit risk weightings accordingly will have the desired effect. Climate risks take years or even decades to crystallise, while most bank loans have three- to five-year maturities. Viewed over such short horizons, climate risks may not move the RWA needle that much. 

Why should a green project get X% less RWA against it? To be honest, it’s arbitrary

Hervé Duteil, BNP Paribas

Natixis has dealt with this by pricing climate risks over the life of the asset being financed – whether that is a windfarm or a power plant – rather than the term of a loan. The firm says this makes sense because most loans are rolled over at maturity and will likely remain on the balance sheet for many years. Pricing in climate risks at the outset means the firm can avoid deals that will have a materially different risk profile a few years down the line.

It’s unclear at this point if Natixis’s GWF will be adopted more widely. Some banks are fans of other approaches, such as carbon pricing. When analysing borrowers in carbon intensive sectors, BNP Paribas applies a ‘tax’ on earnings for every metric tonne of emissions the company produces. ING also prefers carbon pricing over green weightings.

Whichever approach wins out, one thing seem clear: banks are finally taking climate change seriously, and taking steps to mitigate its effects.