Can Capital Offset Carbon

Sustainability has never been more relevant; it’s a factor in the debate on working from home versus office, and the regulatory position of the Bank of England is clear.

As is often the case, risk is at the heart of this agenda. There has already been much work done on disclosure and retaining capital against transition risk, particularly in systemic and more heavily supervised institutions.

The next step for lenders who wish to monitor, manage, and mitigate this risk class is embedding climate risk in day-to-day activity for lending, monitoring, and action (for example concentration risk) and in understanding where lending strategy interaction between climate/sustainability and prudential risk lies.

The Bank outlines 5 goals and lays out a 10 step pledge to meet them. This article considers the first three goals as the final two are the BoE role internationally and internally.

The first five of the ten pledges sit against the three goals of resilience, transition, and disclosure. Some key points of those pledges are summarised below.

• Pledge 1 The PRA will embed climate change in its approach and actively supervise
• Pledge 2 The Bank will call for research and update approach to capital use end-2022
• Pledge 3 By end-2022, the Bank will set out its future strategy for scenario analysis
• Pledge 4 The PRA will explore and update how transition plans are used in supervision
• Pledge 5 Disclosure is a cornerstone. The Bank will work internationally to advocate

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Much of the banking and financial sector work done so far regarding these pledges falls in the areas of holding capital against transition risk in the asset base and reporting on the sustainability features of that asset base.  

Abel’s client risk appetite for application decisioning criteria allows a lender to set exclusions or ‘climate mandates’ by industry sector and our monitoring shows climate sustainability scores alongside forward looking economic prudential health data (amongst other information)

This ensures that not only is climate embedded in BAU, but also that the correct information is gathered in anticipation of a likely IFRS publication alongside pledge 5 above. ________________________________________________________________________

Then we turn to internal sustainability. Abel has a range of automation functionality that removes carbon heavy activity.

If we take the example of a traditional approach to invoice finance, there is a heavy workload in client on boarding, visiting, auditing, and due diligence on either side of the buyer/seller transaction.

At Abel we believe that this is unnecessary for, at least, smaller tickets. Our services are built upon risk:reward principles that enable automated decisioning and monitoring.

• There is sufficient correlation between credit history of key directors and commercial entity (assuming a minimum length of incorporation or operation) to offset risk associated with physical inspection by price, conservatism, or a combination of both.  
• Speed of decision and superior experience offsets the borrower impact and any adverse selection risk, arising from mitigation through price or conservatism in the point above.  

And crucially the prudential risk arising from not undertaking these visits, is more than offset by the reduction in lenders' carbon footprints.

Can capital offset carbon? At Abel we believe that this example shows that it can, and that automation of lending, management and monitoring processes using innovative risk and decision capability, in the general case, can provide the capability for offset decisions like this to be taken.  

You can learn more about our capabilities at Abel here, or to discuss any of the above in more detail, please do get in touch.