How can financial institutions respond to climate change

The climate crisis is a far-reaching global turning point that financial institutions cannot ignore. Rising temperatures, extreme weather events and sea-level rise pose significant risks to the planet's financial stability and long-term economic prosperity. Other risks that directly threaten FIs include asset stranding, increased insurance costs, regulatory risks and reputational risks. Delaying action will only exacerbate these risks and increase the costs of mitigation and adaptation.

As the climate crisis worsens, it is likely that countries will increase carbon taxation. FIs may see that they have facilities in troublesome locations (sea level rise, hurricanes etc.) and may harden those locations to avoid future damage or relocate to lower-risk locations to avoid facility damage, increased costs and loss of revenue during weather events.

But the good news is, there are competitive opportunities for financial institutions that take proactive steps to reduce their carbon footprint and support the transition to a low-carbon economy through ESG goals. By doing so, financial institutions can avoid future costs, mitigate risks, seize opportunities, enhance their reputation with customers and stakeholders and-oh, yes-contribute to a more sustainable future.

Because much of a FI's carbon footprint is generated within the supply chain, that supply chain presents a myriad of opportunities to rise to the climate challenge.

And the good news continues: because much of a FI's carbon footprint is generated within the supply chain, that supply chain presents a myriad of opportunities to rise to the climate challenge.

How financial institutions are responding

FIs around the world today are responding in vastly different ways to growing expectations from governments, stakeholders and customers around climate issues. While the pressure to meet climate goals can be challenging, the increasing demands of customers and stakeholders are creating a powerful incentive for change.

And that pressure is strategically placed, because FIs have tremendous power to drive the global energy transition-perhaps most importantly, by curtailing investments in fossil fuel production and companies that refuse to comply with climate mandates and, conversely, increasing investments in clean energy projects and infrastructure. As they say, follow the money.

FIs like the UK's NatWest Group have made public commitments to reduce their carbon footprints in the light of the global energy transition from fossil fuel. But across the industry as a whole, the pace of progress has been uneven. Some have made significant strides while others have been slower to adopt sustainable practices.

Increasingly, FI leadership is recognizing the long-term risks associated with climate change and the imperative of sustainable practices. This shift is driven by a confluence of factors, including:

• Regulatory pressure: Governments worldwide are enacting stricter environmental regulations and introducing financial incentives for sustainable investments.
• Reducing financed emissions: Institutional investors, such as pension funds and insurance companies, are increasingly demanding that their investments align with environmental, social and governance criteria.
• Market risks: Climate change poses significant financial risks to businesses and economies, making it imperative for financial institutions to assess and manage these risks.
• Credit cost: Climate is also being considered in credit ratings, which can impact the cost of borrowing.
• Reputation and brand image: Consumers and stakeholders are increasingly concerned about corporate sustainability and are putting greater pressure on FIs to demonstrate genuine commitment to ethical and responsible practices.

But not every unit of carbon used on behalf of an FI is generated by that FI. Much of it is generated by the FI's suppliers on its behalf. And so, just as a FI is influenced by governments, shareholders and customers, that FI is in a position to leverage its relationships with suppliers to reduce energy consumption and carbon emissions at every point along the supply chain.

Supplier reticence: the struggle is real, but so is a FI's influence as a customer

Suppliers, often under significant pressure to maintain profitability and meet customer demands, may face very real challenges in implementing sustainable practices. These challenges can include:

• Cost barriers: Investments in sustainable technologies and practices can be costly, particularly for smaller suppliers.
• Lack of expertise: Suppliers may not have the necessary knowledge or resources to develop and implement sustainable strategies.
• Supply chain complexity: Managing sustainability across complex supply chains can be challenging, especially for FIs with numerous suppliers.

But when that supplier's customer, particularly when it's a FI with significant buying power, demands that they adopt sustainable practices, the challenges above seem less important given that FI's purchasing power. (Sometimes it's amazing how much more interested companies can become in factors their FI customers feel strongly about!)

An FI has the power to influence its supply chain to adopt sustainable practices-in turn improving its own sustainability track record.

An FI's influence over vendors in its supply chain can take many forms, from friendly encouragement to financial incentives like contractual commitments, preferential lending rates and investment opportunities on the "carrot" side to pulling contracts to reduce sustainability risks on the "stick" side.

This type of influence can create a powerful ripple effect across the financial services industry and, indeed, across the world. It can:

• Drive innovation: Suppliers may be forced to develop new technologies or processes to meet their customers' sustainability requirements. Proactive suppliers will see this as an opportunity to develop and launch new technologies and products that support the customers' goals, while creating new revenue streams for the supplier.
• Level the playing field: By creating a competitive advantage for sustainable suppliers, customer pressure can incent companies to adopt best practices.
• Accelerate industry-wide change: As more and more companies demand sustainable practices from their suppliers, it can occasion a tipping point that leads to widespread adoption of sustainable standards. For example, the US auto industry adopted the ISO standard across the board and forced all their suppliers to also adopt it. It then flowed down through the various supplier tiers and now it is the global manufacturing quality standard.

Retail giants like Walmart and Target have used their purchasing power to drive sustainability initiatives among their suppliers, focusing on issues such as waste reduction, energy efficiency and ethical sourcing. Tech giants like Apple and Google have implemented strict supplier codes of conduct that require their suppliers to meet environmental and social standards.

Effective climate initiatives FIs are promoting

FIs are under growing pressure to address their environmental impact, including their role in financing carbon-intensive industries. Many have increasingly incorporated environmental factors into their lending and investment decisions. Many have also significantly influenced their supply chains.

There's a growing trend towards supply chain risk management, which includes assessing environmental impacts via carbon accounting protocols such as The Greenhouse Gas Protocol. Use of such tools increases awareness that can indirectly lead to efforts to reduce emissions.

The GHG Protocol outlines three "scopes" of emissions. While FIs primarily focus on their direct (Scope 1) and indirect (Scope 2) emissions, there's increasing attention to (Scope 3) emissions, which include those from the value chain. This could encompass transportation emissions from suppliers.

In the EU, a new regulation called the Corporate Sustainability Reporting Directive began a staged rollout in July of 2024. Its aim is to foster sustainable and responsible corporate behavior in companies' operations and across their global value chains. Companies subject to the directive will be required to assess their environmental, social and governance risk in the supply chain and develop mitigation plans for identified risks.

FIs are using their leverage to screen suppliers for sustainability risks and engage with them to promote sustainable practices. Requiring suppliers to disclose their sustainability performance can increase supply chain transparency and accountability.

Increasingly, FIs are publishing sustainability reports-in their annual reports and elsewhere-that detail their efforts to reduce their environmental impact, including their carbon footprints. Many are also acknowledging the parts their suppliers are playing in that effort by sharing success stories of suppliers that have robustly pursued sustainable practices, encouraging others to follow suit.

Specific FI initiatives include:

• Reducing product weight: Calling on suppliers to reduce the weight of products and materials, which can lead to significantly lower transportation costs and reduced emissions. (Changing products can be expensive, so manufacturers are often hesitant to do so, but when your biggest client asks . . . )
• Reducing truck rolls: Exploring strategies for optimizing supply chains and reducing the number of truck deliveries, including consolidation and technology-enabled solutions. (Sometimes products that weigh less also tend to take up less room on the truck.)
• Reducing financed emissions: Making it known that the FI prioritizes suppliers-including those that support its investment and lending activities-that commit to sustainable practices, including reducing greenhouse gas emissions.
• Shifting to renewable energy: The increasing adoption of electric vehicles in transportation, including delivery fleets, can contribute to cleaner air; FIs are influencing suppliers to make this shift.
• Favored supplier: Prioritizing suppliers that are receptive to AI adoption, offering preferential lending rates or green loans to suppliers that invest in AI-driven energy efficiency projects, allocating funds for AI research and development projects that support the energy transition.
• AI expertise and resources: Leading FIs are incorporating AI-driven strategies and performance metrics into supplier contracts, providing access to in-house AI experts or external consultants to assist suppliers in adopting AI solutions, developing or partnering with technology providers to offer AI platforms and tools to suppliers and offering incentives or rewards to suppliers that demonstrate successful AI implementation for energy transition goals. Yet AI may be a double-edged sword. While it can help identify ways to reduce energy consumption and carbon emissions, it can also increase energy needs. For example, an AI query can use 10X the energy of a Google search. FIs will want to be careful that their use of AI is not increasing emissions in one area while reducing them in another.
• Measurement and reporting: Documenting your FI's sustainability initiatives is key to demonstrating progress to customers and stakeholders, as well as compliance with government mandates. Metrics on supplier sustainability performance are an important component of a FI's own performance metrics.
• Collaboration and partnerships: Identifying opportunities for collaboration in partnership initiatives between FIs, suppliers and other stakeholders-many of which are already working to promote financial inclusion by providing services in new and innovative ways-are important both to sustainable change and in documenting your FI's performance against it.
• Circular economy strategies: Encouraging supplier efforts in keeping with circular economy principles, for example: designing products with interchangeable parts, using durable materials that can be recycled or reused, offering products as a service rather than selling them outright for better lifecycle management, product take-back programs, sharing initiatives to extend the lifespan of products and investing in technologies to improve recycling rates and quality and convert waste to energy.
• Committing to Net Zero: Making the commitment to and calling on suppliers to make the commitment to Net Zero Banking, with a goal of reducing greenhouse gas emissions by aligning lending and investment activities with the goal of net zero emissions.

Examples of FIs around the world taking initiative to influence their suppliers to take climate initiatives include:

• BNP Paribas: This French bank has set ambitious sustainability targets and uses its lending power to encourage its clients to adopt sustainable practices.
• JPMorgan Chase: The bank has developed a supplier code of conduct that outlines sustainability expectations for its suppliers.
• UBS: This Swiss bank has launched a sustainable finance platform to connect investors with sustainable projects and companies.

A key opportunity for FIs

An FI has great power to influence the adoption of sustainable practices throughout its supply chain, in turn improving its own performance against sustainability criteria, satisfying the expectations of its customers and shareholders and contributing to a more sustainable and resilient economy.

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