Empowering green finance with technology

go through zlata huddlestonPartner and Sustainability Leader, IBM Consulting

fFinance is an industry like any other—it’s in business for a return. Investors put money in to get a positive outcome. However, financial performance results are not the only type of results investors should be tracking in the new climate economy. If the world faces the existential threat of climate change, if we radically change the way we live and do business, a greener financial system should align environmental needs with financial goals.

Green finance is booming, and the global green bond market is worth investing in $2.36 trillion by the end of next year; however, green finance is more than financing or investing in the SDGs.Recently, define green finance has evolved into any financial activity considering a transition to a green economy.

Today, green finance includes not only the role of the financial services sector in financing the reduction of global carbon emissions, but also the identification, adaptation and mitigation of climate change risks (aka climate risk). Banks, in particular, must integrate governance, strategy and risk management frameworks into their operations to effectively manage the climate risks inherent in their operations and portfolios. As well as being under pressure to finance their clients’ transition to a green economy through sustainable finance activities, banks are also responsible for knowing the emissions they finance (or the emissions of their borrowers). There is also momentum: failure to manage climate risk could put a bank’s assets and profitability at risk; failure to report climate risk and financing emissions could jeopardize a bank’s relationship with shareholders and regulators; Funding the transition to a green economy could drive away the banks’ corporate and consumer clients. All of these are necessary for the continued growth of global economic activity.

The industry needs to act quickly.these years IBM CEO Study Shows executives across all industries feel pressure to act on sustainability amidst business challenges and uncertainty, yet 59% of global CEOs say unclear return on investment (ROI) and economics to realize sustainability use cases Benefits are the biggest challenge to achieve their sustainable development goals. For sustainable development to succeed, we need to see greater investment in data and exponential technologies that drive streamlined climate risk and financing emissions management and reporting as components of new sustainable infrastructure. But this investment needs to be fast and consistent.

inertial risk

Regulatory disclosure and reporting requirements are key drivers of technology-enabled sustainability and climate-focused activities in banking today. Reporting standards are rapidly evolving globally for regulatory, consumer and investor driven purposes.

  • The U.S. Securities and Exchange Commission (SEC) will require registrants to disclose qualitative and quantitative climate-related risks and metrics;
  • The Corporate Sustainability Reporting Directive (CSRD) of the European Financial Reporting Advisory Group will replace the current reporting directive and is part of the European Green Deal;
  • The newly formed International Sustainability Standards Board (ISSB) is developing harmonized sustainability reporting and disclosure standards; and
  • Voluntary recommendations published in 2017 by the Financial Stability Board’s (FSB) Task Force on Climate-Related Financial Disclosures (TCFD) have now formed the basis for mandatory climate disclosure rules for many regulators around the world.

Climate physical and transition risks are being described and quantified to better understand the impacts of climate change on banks and their clients. Those banks that do not adopt and adapt may have a negative impact on their operations, for example:

  • High regulatory costs lead to reduced profitability, non-compliance can lead to fines, high unexpected and mandatory technology integration costs;
  • Credit losses due to limited understanding of climate risk in banks’ credit portfolios;
  • Insufficient liquidity due to credit rating downgrades due to failure to meet strategic goals and regulatory expectations;
  • Capital adequacy was negatively impacted due to new requirements for higher capital allocation.

Technology enables change

The TCFD requires banks to report on both climate change risks and climate change opportunities. Sustainability is now seen as a differentiator and an opportunity to extend banking services to corporate and retail clients. Here, the need for data and technology can provide useful insights to take the right action.

Technology is critical to understanding and safely transporting the climate-related data needed to model the climate risk of a portfolio and quantify that risk from a financial perspective. From data management systems like Data Fabric to artificial intelligence (AI) to blockchain, financial institutions must first invest in technology to ensure they can make strategic changes. Banks can also conduct their infrastructure assessments as part of their annual technology planning process and start planning how hybrid cloud architectures can leverage system improvements from a sustainability perspective.

AI can help more accurately measure greenhouse gas (GHG) emission reductions against established targets, improve analytics to predict the impact of acute (floods, wildfires) or chronic (sea level rise) climate events on bank assets, assess the Current state low-carbon financing and modeling of a bank’s lending book against its sustainable finance framework prior to green bond issuance.

It’s not perfect…yet

Banks are increasingly aware of climate- and customer-related data gaps, requiring automation of estimation techniques to perform the required analysis. In addition, the lack of consistency among sustainability taxonomies is also a problem.

An example of a major data gap in the client-related data required for financing emissions calculations is the GHG emissions of private commercial borrowers. AI-driven automation can help scale modeling for estimation techniques. AI can also support banks’ financing emissions and transformation risk measurement and sustainable finance use cases through an industry taxonomy standard that is scalable and adaptable across the banking enterprise.

Imperfect action is better than no action at all. It can start with a mixed approach, but small steps are better than nothing.

how to start

Start with a centralized, enterprise-wide climate data strategy to define key climate initiatives—identify data needs and internal and external data sources—and evaluate a variety of technical tools. Your bank’s strategic focus should be on ingesting, processing and modeling climate and related data, identifying priority use cases, mapping data needs, assessing data gaps, and engaging all internal stakeholders on common principles, business architecture and green fintech solutions Be consistent on the roadmap. Pay special attention to assessing data gaps, acquiring external data, and addressing data quality issues. Incorporate computation and analytics into the technical architecture and introduce tools to support data consumption, including reporting. As climate regulatory guidelines and regulations evolve, a hybrid cloud approach will ensure the required adaptability, flexibility and scalability. AI-based tools can help drive consistency in climate taxonomies, such as industry classifications. Finally, integrating the output with the bank’s current processes and systems deserves its own strategic technology plan, as it can be achieved through a range of solutions, from simple dashboards to sophisticated machine learning (ML) techniques.

The key is to get started and start with a technology enablement strategy.

in conclusion

Sustainability is mainstream. Green finance is not just the future; it is happening now. Shareholders and society expect it, and governments increasingly regulate it. Soon, financial returns will depend on the sustainability credentials of the investment. Financial institutions must improve their ability to identify climate risks, collaborate across sectors and act on data insights in real time. The changes come fast and thick. The right data and technology will allow green finance to flourish. Together, they will help identify climate risks and sustainable business benefits, as well as better and more efficient financial decisions.

about the author

zlata huddleston is a Partner and Sustainability Lead in the IBM Consulting Practice. She has over 25 years of experience in the global financial services industry, including corporate and investment banking. Prior to joining IBM in 2020, Zlata was Senior Vice President and Head of Financial Institutions at Wells Fargo Bank in Canada.

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