• Thu. May 23rd, 2024

Financial accounting rules could lower clean-energy returns relative to fossil fuels | News

Financial accounting standards applied by banks could inadvertently lead to lower returns on renewable-energy investments being reduced relative to fossil fuels, new research suggests.

In a study published in Nature Climate Change this week, researchers at the University of Oxford set out how statistical models widely used by banks to comply with financial regulations produce a lower risk rating for high-carbon sectors than low-carbon sectors.

Focusing on IFRS9, the researchers found that banks needed to account for nearly double the loan-loss provisions for lending to low-carbon sectors as compared with high-carbon sectors, meaning that withdrawing from high-carbon assets could be costly for banks.

IFRS9 is an accounting principle that was developed in response to the global financial crisis, with one of the key changes being a move away from an incurred-loss to an expected-loss impairment model.

Eric Beinhocker, executive director of the Institute for New Economic Thinking at the Oxford Martin School and one of the authors, said that while the researchers do not have direct evidence that renewable debt financing costs are systematically higher due to the effect of the rules in question – as that would be a different study – “it is not unreasonable to assume that banks will pass on their higher capital charges to renewable lending”.

“If that were the case, higher relative debt costs would in turn lower the relative equity returns versus what they would be without the effect we identify in our paper,” he told IPE in a statement.

The Oxford researchers said the bias shown towards high-carbon assets in financial accounting rules “probably emerges from the backward-looking nature of risk estimates”, with the average historical financial risk of the oil and gas sector consistently estimated to be lower than that of renewable energy.

More generally, they said that, by directly impacting banks’ profitability, the unintended side effect of model-based risk frameworks “might impair the transition towards net zero carbon emissions and in turn contribute to increasing the build-up of transition risk in the financial system”.

Matteo Gaspirini, lead author of the study, said: “Financial, supervisors, regulators, standard-setting bodies might consider this in their work and further research is also needed to better understand how this might impact broader environmental objectives.”

Beinhocker said banking regulation needed to be updated to be more forward-looking, “to take into account the fact that clean energy technologies are now much cheaper, supported by policy and less risky, and doing this will help shift capital toward the clean energy future”.

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