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Green bank borrowing sets down roots

Green bonds represent a small share of bank borrowings. However, that proportion is expected to rise considerably in the coming years. Miroslav Petkov, Director in the Sustainable Finance Team of S&P Global Ratings, considers the recent – and future – growth of banks’ green issuance

Banks have a significant role to play in the transition to a low-carbon economy. As key providers of funding, it matters where they put their money. Banks have already boosted their issuance of green bonds – toUS$27 billion in 2017 from US$1.5 billion in 2014, based on Climate Bonds Initiative (CBI) data(adjusted to include green bonds for large-scale hydro or clean coal projects). Over the same period, the number of banks making their debut in the green bond market increased to 72 from just five (see chart: Number of Banks Issuing Their First Green Bond). And with climate change a priority on global political and economic agendas, we believe that this strong growth will continue. 

Green beginnings

Miroslav Petkov
Miroslav Petkov

The OECD estimates that green investment will likely have to exceed US$4.3 trillion annually in order to meet ambitious climate goals – led by the Paris Agreement target of keeping global warming from rising 2°C above pre-industrial levels. In the EU, U.S., China and Japan, which represent the best-established bond markets, the equivalent amount is $2.2 trillion, with about one-third of that projected to be financed through loans. The amount of green bonds that banks are currently issuing is small compared to the OECD’s estimates of required annual green investment.

Green bonds also represent only around 0.5% of banks’ total current borrowings, and a nominal amount of total bond issuance (about 1% in 2017). What’s more, green bonds have not yet become a regular channel for raising capital for many banks. The large majority of the top 200 banks – about four-fifths – haven’t yet issued any green bonds.

But as the realities of climate change set in, green investments are increasingly in demand. As such, banks around the world may face peer and investor pressure to ramp up their efforts in the green bond market. Green bonds can provide the means for banks to finance green investments and increase the proportion of their funding that is considered green. And we believe that banks can subsequently use their status as issuers of green bonds to other ends as well, in particular, to demonstrate to stakeholders their own contribution to the low-carbon economic transition.

Climate Bonds Initiative Chart
Climate Bonds Initiative Chart

What do we mean by “green”?

Many banks are still in the process of defining what green assets actually are. This is because identifying green investments within a bank’s portfolio is challenging. While there are many initiatives to define what green investments are, the reality is that there are shades of green depending on the investment’s contribution to the transition to low-carbon economy.

Moreover, if banks understate their green portfolio, they face the increased risk of unfavourable comparison to their carbon-intensive portfolios. And with some nongovernmental organisations monitoring and reporting on these, this could raise reputational risks.

So bank issuers rely on standards to define which investments are green. The Green Bond Principles (GBP) are the most widely used. A notable exception is China, where all onshore green bonds follow the People’s Bank of China’s (PBoC) guidelines.

Green bond frameworks

One factor that defines the level of greenness of banks’ green bond issuance is their green bond framework. Banks typically set up such a framework to define how assets financed through green bonds are selected – and how the proceeds are managed thereafter. The framework also covers reporting on the use of proceeds.

Often, most of the assets backed by green bonds are existing financings. In that sense, such green bonds do not generate new green assets. However, we believe the green bond market will stimulate banks’ future green financings as it would allow banks to issue green bonds once they have generated sufficient volume of new green assets through their lending activities.

What we also see is that banks’ green portfolios are dynamic – increasing or decreasing with new issuance, redemption, and reclassification of green assets or lending. Most green frameworks allow for the possibility of the amount of the green portfolio to drop below the green bond proceeds temporarily, with the balance invested in money market instruments or other green bonds. However, in practice, the green bonds portfolio typically exceeds green bond issuance for most banks by a substantial margin – some even by more than 50%.

A global, green landscape

Notably, Chinese banks have contributed significantly to the increase in green bond issuance. This has been as a result of the government’s decision to create and formalise a green financial system in China – and the subsequent publication of green bond guidelines by the PBoC in 2015. Now, Chinese banks represent more than 50% of total green bond issuance by banks, as well as around 40% of the number of green bond issuing banks. (see chart: Breakdown of Bank Green Bond Issuance By Region).

China stands out in other ways, too. Pollution prevention and clean transportation represent the largest share of green bond allocation in the country. In contrast, for around two-thirds of the top 200 banks outside of China, renewable energy and green buildings hold more than a 90% share.

Breakdown Of Bank Green Bond
Breakdown Of Bank Green Bond

Moreover, the majority of banks’ green assets operating in developed countries are located in their own region. In turn, this may have implications for reaching global climate change goals, as – according to the Paris agreement – developed countries need to work to contribute to the green transition in emerging markets.

We observe that the contribution of banks in developed countries to that transition is currently limited. For some developed banks, this may reflect their more limited market presence in emerging markets overall. For others, the key reason may be the typically higher credit risk of investments in emerging markets.

We expect all banks to continue to grow their share of green bond issuance in the near future. By significantly expanding their contribution to the green bond market, banks can work alongside corporate, municipal and sovereign issuers – and strive to meet the ambitious climate change targets.

To find out more, please read S&P Global Ratings’ report entitled “A Look At Banks’ Green Bond Issuance Through The Lens Of Our Green Evaluation Tool”, available online here.