Trucost News / 22 Apr 2016

New research shows Chinese banks how to reduce the risk of financed environmental impacts

Trucost finds that China’s banks are exposed to costs of RMB 11 trillion as a result of the environmental damage caused by industries they finance.

China’s banks are exposed to costs of RMB 11 trillion as a result of the environmental damage caused by industries they finance, according to new research to be published tomorrow (23 April) at the People’s Bank of China Green Finance Committee’s annual conference in Beijing. The research provides a new tool for financial institutions to analyse the environmental risks to loan repayments and investment returns at a sector level.

The Green Finance Committee, which supported the research, says that China’s financial institutions and policymakers are failing to effectively consider the environmental costs of industrial activities in decisions about loans and investments. To address this challenge, Trucost partnered with the Urban Finance Research Institute of the Industrial and Commercial Bank of China (ICBC) to create the tool.

The tool enables Chinese banks and investors to understand and manage the risks they are exposed to through their corporate loans and equity investments in environmentally damaging sectors. The tool works by calculating the cost of damage to the environment and human health caused by air pollution, climate change and water scarcity among other environmental issues. It identifies factors that are forcing sectors to pay for these external costs through tighter emissions control standards, commodity price volatility and resource scarcity.

Trucost analysed RMB 10.3 trillion of outstanding credit provided by Chinese banks as of the end of 2014 to 35 business sectors including agriculture, energy generation, steel, cement and chemical manufacturing.

The results show that the total environmental cost of this finance is RMB 11 trillion, meaning that each RMB 1 million of credit provided by Chinese banks results in environmental impacts costing RMB 1.07 million.

Greenhouse gas emissions are the largest impact associated with Chinese bank finance, accounting for 74.5% of the total environmental cost. The impacts of land use change are second at 11% of the total environmental cost.

The most damaging sector is coal power generation, which is responsible for 26.1% of the total environmental cost – more than any other sector. Managing the risks from this sector is a priority for China’s commercial banks.

The 25 manufacturing sectors assessed are responsible for 51.3% of the environmental costs. Plant closures to reduce China’s over-capacity as well as more stringent environmental regulations will internalize these unpaid environmental costs, creating risks for banks that finance the sectors.

The three agricultural sectors analysed – rice farming, cattle ranching and poultry production – contribute to 11.8% of the environmental costs, despite representing only 1.43% of loans made by banks. This underlines the high costs associated even with small loans to environmentally damaging sectors. The environmental costs of the three sectors ranged from RMB 4.64–14.65 million per RMB 1 million of credit. The agricultural sector’s relatively high non-performance rate compared with other sectors makes it more vulnerable to additional costs associated with environmental impacts.

The research recommends that Chinese banks incorporate a consideration of environmental costs into credit risk management processes. This assessment needs to include the full range of factors driving the internalization of environmental costs onto company accounts. Equity investors should incorporate a consideration of environmental costs into equity research and valuation processes to minimize risk exposure. The research goes beyond awareness raising to provide a practical tool for banks and investors.

The research also recommends that Chinese banks and investors take advantage of the opportunities from the transition to a greener economy. In many sectors, there are policies in place encouraging improvements in environmental performance which will require finance by businesses. This is a trend that is certain to continue as China aspires to achieve sustainable economic growth.

Chaoni Huang, Trucost’s head of business development in Asia, said: “Chinese banks and investors face a complex landscape of risks and opportunities resulting from policies driving the transition to a clean, low-carbon economy. This research and tool provides action-driven insight for financial institutions to understand, quantify and manage these risks and benefit from the opportunities.”

Zhou Yueqiu, director of the Urban Finance Research Institute, Industrial and Commercial Bank of China, said the research “provides insights and positive support to business transformation and optimization of the loan structure of the banking sector. In the future, we need more similar research and tools, and to actively strengthen the foundation of green finance in China.”

Further information

Download Accounting for Natural Capital Costs Associated with Chinese Financial Institutions – Banking Sector Case Study

Media contact

James Richens, +44 (0)20 7160 9800, james.richens@trucost.com