Bank financing of the fossil-fuel sector remains strong despite intensifying global efforts to combat climate change since 2016, after the Paris Agreement was signed.

Between 2016 and 2019, fossil-fuel financing by the top 60 global commercial and investment banks logged a compound annual growth rate (CAGR)¹ of 5.1%. The incremental financing support peaked at $43 billion in 2019, growing 5.5% on-year to $824 billion.

In 2020, such financing support declined $73 billion, or 8.9% on-year, to $751 billion. Even so, it exceeded the 2016 and 2017 levels.

As such, the decline in 2020 may be attributed to depressed energy markets rather than to climate risk initiatives. Going by industry estimates, but for the Covid-19 pandemic that left energy markets debilitated, fossil-fuel financing would have touched closer to a trillion dollars, last year.

A closer look also reveals that fossil-fuel financing remains skewed toward large banks. In 2020, the world's top 15 fossil-fuel financers² (see table) accounted for ~56% of the total and the top five US banks accounted for a quarter of the total.

Underwriting takes top spot in 2020, keeping a leash on direct credit exposure to energy sector

The energy sector relies heavily on debt and equity capital markets to fund long-term needs, and explores bank loans largely to meet short-term requirements.

In 2020, 65%³ of fossil-fuel financing was through underwriting of bond and equity issuances, which remained an attractive source of fee income for banks. Indeed, for the world’s top 15 financiers, fees generated from fossil-fuel issuances over 2016-20 were more than three times higher than those from green issuances.

True, the commercial credit exposure of banks to the energy sector (see table) averages ~5%⁴ – not large enough to pose a systemic risk. But even such low exposure acts as a primary source of climate-related risk and has the potential to elevate systemic financial risk in the long run.

Pandemic-led energy crisis drives increased scrutiny of fossil-fuel financing

The pandemic-induced energy crisis has brought the oil and gas⁵ exposure of banks and their climate-risk response under increased scrutiny of central banks and regulatory watchdogs across the world.

In this milieu, banks have initiated some proactive measures such as prohibiting funding for Arctic drilling and oil sands projects, but these efforts appear to be symbolic rather than concrete steps to substantially address transition risk. Indeed, such measures are a win-win for banks as these projects are already uneconomical in the current oil scenario and are highly carbon-intensive at the same time. 

Thus, while banks are looking at enhancing their due diligence process for high-carbon projects, any explicit policy to exclude financing to the oil and gas sector seems distant for now (see table).

That said, the pandemic-led energy transition will intensify regional disparities among banks in their commitment to curb climate risk. 

As things stand, European banks fare better than their US counterparts in terms of exposure to renewable energy, given Europe’s lower dependence on fossil fuels (2020 consumption mix: Europe 71% vs. US 82%). Accordingly, European banks are better placed to revise their fossil-fuel financing priorities more rapidly than other regional counterparts. Among US banks, on the other hand, realignment will be relatively slow given the region’s high dependence on fossil fuels.

Fossil-fuel financing set to rebound on reopening of the economy and strong energy fundamentals

Once the impact of the pandemic diminishes and energy demand rebounds, we believe banks' support to fossil-fuel financing will recover. Global banks still foresee further energy growth over the next decade, given the rising energy demand in India, China and the US, and fossil fuel's role in ensuring affordable energy supply.

Even under two scenarios⁶, ‘Business as usual’ and ‘Rapid’, fossil fuel’s share in the global energy consumption mix is likely to come down to only 78% by 2030 and 67% by 2030, respectively, from 83% in 2020.

Banks continue to show their commitment to the Paris climate accord by increasing exposure to green financing, but a trade-off with their fossil-fuel financing appears unlikely in the near term.   

¹  Includes lending and underwriting of debt and equity issuances; As per the study “Banking on Climate Chaos: Fossil Fuel Finance Report 2021” authored by Rainforest Action Network, BankTrack, Indigenous Environmental Network, Oil Change International, Reclaim Finance, and Sierra Club
² Top fossil fuel financiers based on past five-year financing trend
³ Includes lending and incremental underwriting of debt and equity issuances; As per the “Banking on Climate Chaos: Fossil Fuel Finance Report 2021”
⁴ Average based on the top 15 fossil fuel financiers credit exposure to energy sector by total wholesale / commercial credit exposure
⁵  69% of the total fossil fuel financing from 2016-20 was for oil and gas companies as per “Banking on Climate Chaos: Fossil Fuel Finance Report 2021”
⁶ As per BP’s world energy outlook. Rapid scenario assumes policies and actions targeting to reduce carbon emissions from the energy sector by 70% by 2050