How to limit banks’ appetite for carbon-spouting borrowers

“Too much of anything will make you sick.”  It’s the plea of frustrated mothers everywhere when trying to convince their little ones that a plateful of chips is not the superb dinner they believe it to be.  The aphorism is also the opening line of the underrated Cheryl single Fight For This Love, but I digress.

In the banking world, the phrase is most appropriately applied to the concept of concentration risk.  This is the danger that a bank gets too exposed to one counterparty, or perhaps a handful of similar counterparties, to the extent that its own solvency is threatened if said companies implode.  “If you owe the bank $100 that’s your problem. If you owe the bank $100 million, that’s the bank’s problem,” as the saying goes. (We should perhaps add: “If you owe the bank $100 billion, that’s the government’s problem” given the experience of the last few decades).

Concentration risk has knocked down a fair few banks over the years. Just look at the once mighty Credit Suisse, which was brought low by a concentrated exposure to the hedge fund Archegos in 2021.  Even more recently, there’s a case to be made that Silicon Valley Bank, which collapsed into receivership in 2023, was a victim of concentration risk – not in relation to its assets, but rather to its deposit liabilities, which were largely to the same flighty crowd of tech entrepreneurs and venture capitalists.

Climate hawks have occasionally made the argument that banks’ exposures to carbon-intensive entities represent another concentration risk.  The argument goes that in a rapid transition scenario, where the price of carbon emissions soars and oil, gas, and coal shrink to a tiny fraction of our energy mix, these exposures could all collapse in value at more or less the same time, taking the banks that invested in them down as well.