Glossy Green Banks: Examining the Gap between European Banks' Sustainability Disclosures and Lending Strategies

Aug. 24, 2023

Banks provide a great deal of information about their environmental initiatives in their sustainability and annual reports. But do the disclosures say anything about their actual lending practices? Stressing the crucial role of regulation, a new study suggests there’s a discrepancy between public commitment and the lending activities of European banks.

A challenge often discussed is how to cut emissions aside from using carbon taxes and regulation. In this connection, banks are under scrutiny for their role in funding green projects and curtailing their relationships with high-emission firms and “brown” industries. As a result, an increasing number of them have begun to communicate more explicitly about how their lending policies help to reduce emissions.

The growing prominence of environmental disclosure, often voluntary and not regulated, poses the question whether banks’ portfolios really reflect their public pronouncements on sustainable actions. More recently, for example, the European Central Bank (ECB) and the U.S. Securities and Exchange Commission (SEC) have started to explore the need for further regulation and auditing of environmental disclosures by banks and listed firms.

In a recent working paper, SHoF’s Mariassunta Giannetti (Stockholm School of Economics), together with Martina Jasova (Columbia University), Maria Loumioti (University of Texas at Dallas), and Caterina Mendicino (European Central Bank) address this concern and examine the relationship between banks’ environmental disclosures and their lending activities.

Giannetti and her coauthors examine newly issued commercial loans of 553 banks issued during the 2014–2020 period, using data from the ESCB’s credit registry, AnaCredit. The registry provides information about the loans, such as the borrowers’ industry and location as well as the loan terms and performance.

The researchers also study the content of banks’ annual and sustainability reports. Using EU taxonomy, they identify and assess the frequency and sentiment of "climate-related" keywords (e.g., natural gas, coal, biodiversity, carbon, pollute, etc.) used by these financial institutions to convey what they do for the environment.

The study’s findings show that banks overemphasize their climate goals while continuing their relationship with polluting borrowers. "Regulating the content of bank disclosures appears to be crucial," Giannetti says.

Bank disclosures increase in countries where there is more attention to the environment

Banks in countries where social economic beliefs and activism favor the environment disclose relatively more about their environmental practices. Furthermore, those banks that portray themselves as more environmentally conscientious appear to pursue greener policies, such as through issuing more "green" bonds.

Giannetti comments: "This makes sense because banks disclose environmental practices to attract investors and customers, thus building a reputation for environmental sustainability."

Banks that stress the environment more in their disclosures lend more to "brown" industries and to high-emission firms

Banks with extensive environmental disclosures lend 3.6% more to businesses in "brown" industries than other banks. When the carbon emissions of borrowing firms increase, banks that stress environmental practices tend to lend about 30% more compared to other banks.

The high-emission firms that receive funding from banks that highlight the environment are more often small firms. "Because loans to small borrowers are the most opaque part of a bank’s assets, incomplete disclosures that omit their discussions are less likely to come to the attention of the banks’ investors and to have negative reputational effects," Giannetti says.

Are banks investing in the transition to greener technologies?

Giannetti and co-authors investigated whether loans may be helping firms in "brown" industries to transition to greener technologies. The latter typically require significant funding due to the high upfront costs associated with research and development (R&D) and fixed assets. But what they found was that environmentally more conscious banks are less likely to lend to firms in "brown industries" with large R&D expenditures.

This analysis was further strengthened when the authors looked into banks’ engagement with new entrants into "brown" industries, those typically more likely to innovate and disrupt old technologies. However, the findings reveal that banks that emphasize the environment extend less credit to young firms in "brown" industries.

Are banks penalizing polluters with stricter contract loans?

Another hypothesis raised by the researchers was whether banks were using the loan terms to discipline firms in "brown" industries. However, they found that borrowers in "brown" industries do not pay higher interest rates for loans from banks that highlight environmental disclosures. They also found that these borrowers benefit from longer-term loans from these banks.

Are banks shifting portfolio proportions?

They also examined if banks could offset this situation by engaging with more borrowers in "green" industries. Although they discovered some evidence that banks with more extensive environmental disclosures try to reduce new lending exposure to "brown" borrowers, their findings indicate that they are reluctant to terminate existing relationships.

Why is there a gap between environmental disclosures and bank lending?

The authors also found that banks that appear more environmentally conscious are more likely to finance unhealthy "brown" borrowers, such as those with low productivity, low profitability, and a low interest coverage ratio.

They explain that terminating lending to unprofitable firms in "brown" industries would force banks to realize credit losses and to discuss and explain their exposure to "brown" industries. "Banks may prefer to renew the loans, in order to keep the borrowers alive and to avoid realizing losses on their balance sheets, a practice known as zombie lending," Giannetti comments.