Significant sums of bank assets will not be included in the scope of the next green assets ratio, revealing the shortcomings of the indicator to accurately compare the environmental, social and governance efforts of European lenders.
The European Banking Authority will require around 150 lenders to publish a so-called green assets ratio, or GAR, from 2024. The ratio is planned as a comparable and harmonized measure showing environmentally sustainable assets as a percentage of lenders’ bank books . Banks will follow a common classification system, the EU taxonomy, to define a “green” asset.
But the ratio may be of limited use in comparing the strength of banks’ balance sheets across the board, as large parts of assets are outside its scope. according to the latest sustainability reports from European banks. For example, assets held for trading and exposures to governments and central banks are completely excluded from the GAR calculation, while funding for small and medium enterprises or non-EU counterparties can never be qualified as green.
These structural characteristics are likely to cause divergence in the coverage and value of the green asset ratio depending on a bank’s business model and geographic footprint.
“You can’t just compare the ratio of two banks and say to yourself, ‘This bank has a higher ratio, so the balance sheet is greener,'” said Simon Brennan, director at Deloitte, who specializes in prudential regulation of banks. . “You must be wondering if these balance sheets are comparable? »
Differing scope and value
Although European lenders are not yet required to publish their GARs, they have already revealed what share of their total assets at the end of 2021 would fall within the scope of the ratio calculation. The numbers vary widely from bank to bank.
BNP Paribas SA has estimated that only around half of its assets will be covered by the ratio, mainly due to its large trading book and exposures to central banks and governments. For Banco Santander SA, a retail-focused lender, 90% of its total assets would be included.
European banks have also disclosed the share of assets within the scope of the green asset ratio that are “eligible for the taxonomy” and as such eligible to be included in the numerator of the GAR. An activity is considered eligible for the taxonomy if it is described in the taxonomy regulation, such as renewable energy or real estate, and therefore has the potential to contribute to one of the EU’s environmental objectives. It is only in 2024 that banks in the EU will have to assess whether these assets actually meet the performance criteria and can be labeled green and be used to calculate the GAR.
The EU Green Rating System currently covers the economic activities of approximately 40% of listed companies in the EU and focuses on objectives related to climate change mitigation and adaptation activities.
Among the top five European lenders by assets, Groupe BPCE has the highest eligibility rate, at 54%. Those of Societe Generale SA and BNP Paribas are the lowest, at 18.4% and 25.8% respectively. Societe Generale has only published the mandatory information at this stage, which must be based on the data provided by the relevant counterparty.
Other banks in the sample supplemented their mandatory reporting with voluntary reporting, which may use estimates and approximations, which increased their eligibility rate.
Currently, assets eligible for the taxonomy are largely limited to bank financing of residential real estate as well as EU companies subject to disclosure obligations under the Non-Financial Reporting Directive. , or NFRD, a part of the EU Disclosure Regulation that applies to certain large companies.
At the same time, funding for SMEs, non-EU counterparties and sectors not covered by the EU taxonomy will be excluded from the numerator but not from the denominator of the GAR. In essence, this means that these assets will be assumed be 0% sustainable in the calculation of the GAR. This puts offnks with large exposures to these segments at a structural disadvantage when looking to increase their RPG. Even if every asset in a bank’s banking book is environmentally sustainable, its green asset ratio could never exceed the eligibility ratio.
A spokesperson for Groupe BPCE said the eligibility rate currently represents “more the nature of a bank’s business” than its ecological character, with its own eligibility rate being mainly made up of its portfolio of mortgage loans. The bank expects the taxonomy-aligned asset ratio — the green asset ratio — be much lower than that of taxonomy-eligible assets, the spokesperson said, acknowledging that comparing banks’ GAR will not always be easy or relevant.
The green asset ratio also comes with other limitations. For example, it only measures green activities and therefore does not necessarily reflect banks’ transition efforts within the banking book as a whole, said Maureen Schuller, head of financial sector strategy at ING. A bank can make significant progress by helping polluting customers reduce their environmental impact without complying with the taxonomy.
An EU-wide pilot exercise on climate risk, published by the EBA in May last year, estimated an average GAR of just 7.9% for a sample of 29 EU banks , although he pointed out limitations such as data gaps and variation in approaches used.
Pilar Gutierrez, responsible for unit reporting and transparency at the EBA, agreed that it would be more relevant to compare the green asset ratio of banks with similar business models, especially those with a predominantly traditional lending business. But, she added, to understand institutions’ ESG exposures and risks, GAR needs to be assessed in conjunction with the range of other disclosure requirements the EBA has introduced under Pillar 3, not in isolation.
Pillar 3 is part of the Basel Global Standard for Prudential Banking Regulation which aims to promote market discipline through regulatory disclosure requirements.
In its proposed framework, the EBA requires banks to disclose information on everything from exposure to carbon-intensive businesses to physical risk related to climate change. It also offers a Banking Book Taxonomy Alignment Ratio, or BTAR, which attempts to fill one of the shortcomings of the GAR by extending the numerator to counterparties not covered by the NFRD. This complementary measure aims to give a more complete picture of the alignment of the taxonomy of banks and to incentivize lenders to provide green finance to SMEs, even if institutions still face significant data availability problems and can having to rely on estimates and proxies when calculating BTAR.
The EBA further intends to introduce a measure capable of capturing ESG risks in banks’ trading books at a later date, Gutierrez said. She said the regulator had left the trading book out of the scope of the Pillar 3 standard for now, as this activity is more volatile in nature, with assets often remaining on banks’ balance sheets for short periods. . This makes it more complex to measure a ratio of green assets and increases the risk that banks “dress” their assets on the day the ratio is calculated.
Over time, the scope of the green asset ratio and data availability will improve to some extent. European companies are now required by the Taxonomy Regulation to disclose information about their own qualifying activities, which a BNP Paribas spokesperson says will improve the bank’s disclosures from 2023. This year, BNP Paribas used NACE codes, the European standard for classifying economic activities, to qualify. taxonomy eligibility for corporate clients, which is an estimate only.
From 2023, the Corporate Sustainability Reporting Directive will further modify existing NFRD reporting requirements, extending coverage to all large companies and all companies listed on regulated markets, although SMEs unlisted are always excluded.
The range of activities eligible for the taxonomy will also increase as the EU plans to publish performance criteria covering more sectors and four other environmental objectives, including pollution prevention and biodiversity protection.
Even though the Green Asset Ratio comes with limitations, it will still be an important improvement in European banks’ ESG publications, as it provides a binding, quantitative and consistent ESG measure that has been lacking until now, Vitaline said. Yeterian, senior vice president for DBRS Morningstar’s Global Financial Institutions Group.
The GAR may not be entirely comparable, Schuller said, but it has nonetheless expects it to fuel investor decisions, which in turn could translate into lower funding costs for banks with a higher ratio.
“The comparison will obviously be made”, Schuller said. “Investors will end up differentiating between banks, because it’s also important for their own information on the green investment ratio.”