Why banks with exposure to carbon-intensive sectors are at risk
What's the story
A recent study by researchers from IIM Lucknow has revealed that banks with high exposure to carbon-intensive sectors are likely to face increased credit risk in the long run. The research, published in the Journal of International Financial Markets, Institutions and Money, highlights the link between sustainability and financial performance. It emphasizes the need for aligning financial strategies with the global shift toward a low-carbon economy.
Indirect impact
Transition risks
Although banks don't directly emit carbon, they indirectly contribute by financing high-carbon industries like fossil fuels and heavy manufacturing. "Financial institutions are exposed to transition risks that are not immediately visible in traditional risk assessment. This research underlines the importance of factoring in sectoral exposure from a long-term perspective, especially in the context of evolving climate policies," said Vikas Srivastava, co-author and ONGC Chair Professor at IIM Lucknow.
Global analysis
Policy shifts
The research team studied a panel of 158 banks across 26 countries. They found that banks with high exposure to carbon-intensive sectors tend to become less efficient over time. This is mainly because these industries are subject to the increasing regulatory scrutiny and policy shifts in a low-carbon transition, making them riskier borrowers. "This results in banks incurring higher credit risk, leading to increased monitoring and recovery costs when loans turn non-performing," Srivastava added.
Innovative approach
Carbon-sector exposure
Sowmya Subramaniam, Associate Professor at IIM Lucknow and co-author of the study, said a key feature of their research is the introduction of a measure of carbon-sector exposure. This combines loan concentration with measure of carbon emissions. "This approach enables a precise assessment of the risks embedded in banks' lending portfolios. The research highlights the importance of strong capital buffers. More capitalized banks can absorb the risks of carbon-intensive lending, limiting the efficiency impacts caused by climate change," Subramaniam said.