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Not banking on carbon markets

The banking sector’s anticipated upswing in investment in the voluntary carbon market has failed to materialise, new research reveals. Why is that? Benja Faecks and Jack Arnold* explain.

Podcast: Watch Miriam Vicente speak with Benja Faecks and Jack Arnold about the role of banks in the voluntary carbon market

A recent analysis conducted by the Columbia Centre on Sustainable Investment (CCSI) on behalf of Carbon Market Watch has shed new light on the involvement of banks in the voluntary carbon market (VCM). Despite optimistic predictions that the voluntary carbon market is on course for unprecedented growth and banks’ support for the scaling up of the market, banks are not as invested in the VCM as they could potentially be. 

A series of interviews CCSI conducted with experts and an analysis of publicly available reports from major banks revealed that these financial institutions are hesitant to commit to the VCM. Banks generally use carbon credits for their operational sustainability strategies, but are reluctant to meaningfully channel finance in the market through investments. Many banks have even lost money in the VCM due to a lack of revenue potential. 

But why are banks shying away from the VCM, in spite of their declared interest in expanding it? What are the implications of this reticence for the future of carbon markets? And are there better avenues for bankrolling climate action?

Risks and rewards

One major factor fuelling the reluctance of banks to dive deeper into the voluntary carbon market are the significant risks involved. While the VCM is often promoted as a vital tool for mitigating the climate crisis by enabling companies to “offset” or “neutralise” their emissions through carbon credits, recent investigations into individual projects and project types have exposed widespread malpractice, such as overestimation of emission reductions, human rights violations, and projects that fail to deliver promised environmental benefits, the exaggeration of climate impact and allegations of greenwashing. 

These problematic developments have raised fears amongst bankers that they may suffer reputational damage if they get involved too closely in the VCM. Heightened media scrutiny, public scepticism regarding the effectiveness of carbon credits and the growing phenomenon of litigation against misleading climate claims and greenwashing might further deter banks from deeper engagement.

In addition, the complexities of verifying and certifying carbon credits make large-scale investments unattractive. 

As a reaction to these risks, banks could channel their finance to tackling these problems, for instance by investing in or funding start-ups seeking to enhance carbon credit quality. Instead, banks prefer to invest in start-ups that facilitate the trading and infrastructure of the VCM, such as auction houses and spot exchanges. This suggests that, in spite of their reticence, banks are more interested in growing the economic size of the market rather than in boosting its climate impact.

Quantity over quality

Current market dynamics show that carbon credits are often priced at just a few dollars per tonne of avoided or reduced emissions. However, the social cost of carbon – a monetary value estimating the socioeconomic harm of emissions  – typically ranges in the hundreds of euros per tonne. This price discrepancy means that companies which use cheap carbon credits to supposedly offset their emissions are transferring the true cost of their pollution to society as a whole rather than shouldering it themselves. This also deters them from making the investments needed for transformative changes in corporate value chains and climate finance. 

Banks often express affinity with carbon markets in their headline communications, highlighting its reputed potential for mobilising quality and transparent climate finance. However, these institutions frequently fall short when it comes to disclosing their own carbon credit purchases. Despite advocating for transparency in carbon markets, banks often remain opaque about the specifics of their credit acquisitions, creating a gap between their public commitments and their actual practices. This murkiness undermines the credibility of their pledges and raises questions about the authenticity of their sustainability efforts.

All of the preceding points risk perpetuating a market that prioritises volume over quality, further complicating efforts to use carbon credits as a genuine tool for climate change mitigation and adaptation. As long as banks fail to invest in improving the quality of carbon credits, any attempts at scaling up the VCM may deliver profits but will do little or nothing for the climate. 

Decarbonising bank portfolios

The quality concerns outlined above explain why banks are hesitant about fully engaging with the voluntary carbon market. This should lead to a more consistent and cautious approach across their operations. If banks were to direct their resources towards more transparent and reliable sustainability initiatives, they would have the chance to enhance their credibility and contribute more effectively to genuine environmental progress.

For starters, banks should prioritise phasing out fossil fuels from their portfolios. Since 2016, the world’s 60 largest banks have provided approximately $6.9 trillion to the fossil fuel industry, a recent Banking on Climate Chaos report showed. This massive financial support dwarfs the relatively modest investments that are truly compatible with the transition to an economy that achieves the goals of the Paris Agreement.

By reducing their exposure to and funding of fossil fuel investments, banks can significantly contribute to global climate goals. Divesting from fossil fuels can help  align financial portfolios with a sustainable future while also sending a strong signal to the wider economy about the urgent need to shift away from carbon-intensive energy sources. It would also reduce the exposure of banks to the risk of future stranded assets (i.e. fossil fuel installations or technologies that will have become obsolete and worthless due to the energy transition, such as oil or gas pipelines, liquefied gas platforms or fossil fuel power stations).

Banks phasing out their fossil fuels would have a more direct and substantial impact on slashing economy-wide greenhouse gas emissions compared to the fragmented and often problematic voluntary carbon markets. Such a strategy would require banks to implement robust policies and frameworks for assessing and mitigating climate risks, fostering investments in renewable energy, and supporting sustainable business practices and public  policy.

Bankrolling the future

The minimal involvement of banks in carbon markets is not necessarily bad news for the climate, especially if investment in the VCM continues to favour quantity over quality. The best service banks can render the climate and their own long-term prosperity is exclusively to loan money to and invest in sustainable economic activities. As the world faces an ever more urgent climate emergency, these findings emphasise the importance of aligning the financial sector with radical action from which the climate benefits.


* Jack Arnold is with the Columbia Centre on Sustainable Investment. His research focuses on investments in mining and energy.


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