A new report – entitled Fossil fuel: the new subprimes? How funding the climate crisis can lead to a financial crisis – reveals that European banks hold massive amounts of assets linked to coal, oil and gas, and would struggle to absorb the value losses these assets will endure, if we were to truly get on track to limit global warming. Considering the risks stemming from fossil fuel exposure is a requirement to protect both the planet and the stability of the financial system. Below our arguments and proposals.

The new report by the Reclaim Finance, Friends of the Earth France and the Rousseau Institute, endorsed by 12 other civil society organizations, reveals that 11 major European banks accumulated 532 billion euros in assets linked to coal, oil and gas. This roughly equates to the GDP of Sweden, and is enough to finance a 20% increase in global renewable energy capacity from 2020.

This large exposure to fossil fuels is yet more evidence that European banks are failing to align with climate objectives. What’s new with our research is that this represents a risk for the stability of the financial system.

Banks are required by law to keep a certain amount of money in reserve – called equity – to absorb the potential value loss of their assets. The “Common Equity Tier 1” of banks is the type of equity that is the most easily usable to absorb value losses and that is directly determined by the assessed “riskiness” of individual assets. As such, it is the equity type that has been used in this report.

It follows from the mismatch between current fossil fuel production plans and the objectives of the Paris Agreement that fossil fuel assets are likely to endure a significant drop in value. While 84% of the explored fossil fuel reserves will have to be left unexploited to limit global temperatures rise to 1.5°C, fossil fuel companies continue to invest in new fossil fuel projects and are not planning a significant scale down of their production. Fossil assets will sooner or later become at least partially “stranded”, leaving the financial institutions holding them with major losses.

However, the fossil fuel stock identified in this report amounts to 95% of the total equity of the European banks studied. Fossil fuel assets represent a very large proportion of the equity of all banks studied, ranging from 68% for Santander to 131% for Crédit Agricole. This means that in the event of a rapid green transition, where fossil fuel assets would lose significant value in a short period of time, banks’ equity could be severely affected. For example, if fossil fuel assets were to lose 80% of their value, Crédit Agricole and Société Générale would not have sufficient equity to cover their losses and the equity of the German Deutsche Bank and Commerzbank would almost be exhausted.

Despite having, on paper, some of the strongest sectoral policies to restrict financial services to fossil fuels – as analyzed in the Coal Policy Tool – French banks are not better prepared or less exposed. In fact, BNP Paribas, Société Générale, Crédit Agricole and BPCE hold a total 260 billion euros of fossil fuel assets, equivalent to an astounding 106% of their equity.

The findings summarized above are not sufficient to say that a financial crisis is coming. The likelihood of seeing a rapid and major drop in value for all fossil assets that would trigger bankruptcies is limited and banks could rely on several other mechanisms to at least partially absorb their losses.

Yet, these findings clearly demonstrate that financial institutions and financial regulators are failing to integrate the risk stemming from fossil fuels. It shows that European banks are overexposed to fossil assets and not prepared to the potential risks they represent, and thus that immediate action is needed to both enable the transition and ensure financial stability.

Moreover, fossil fuel assets are only the tip of the iceberg when it comes to activities exposed to climate risks and the limited transparency of banks makes it likely that the report underestimates fossil fuel holdings. In the event of an unprepared and rapid transition, that follows a time of insufficient action, we cannot rule out a “snowball effect” where all assets even indirectly tied to fossil fuels and polluting activities are affected and – as all financial institutions are exposed to these assets – the crisis spreads.

Two key steps in addressing the climate emergency and protecting financial stability are to urgently stop new investments in fossil fuels and to progressively phase-out fossil fuels, and therefore the related assets.

Cutting off financial flows that allow the development of fossil fuels requires strong measures, well-beyond the current flawed disclosure requirements and voluntary commitments that are being taken. The development of so-called ‘sustainable finance’ is also critically insufficient: it has not demonstrated its ability to further the transition, remains marginal compared to “conventional” finance and could easily turn to greenwashing.

A few major changes that are needed to get on that track are:

• The adjustment of micro and macro prudential tools, notably by adapting capital requirements to the fossil fuel exposure.
• The alignment of monetary operations with the Paris Agreement, starting with ending any support provided to fossil fuel companies by the European Central Bank (ECB).
• A strict restriction of financial services to fossil fuels, using European and national law.

If stopping the expansion of fossil fuels and initiating their necessary phase-out should be the highest priority, something even the International Energy Agency (IEA) is beginning to recognize, doing this without handling the fossil asset stocks of banks could create disturbances and lead to carbon lock-in. The report lays out an innovative proposal for a European ‘fossil bank’ (‘bad bank’) that would be funded through the intervention of the ECB to buy a majority of fossil assets from banks and manage them in a just transition approach. The “fossil bank” would not ‘bail out’ banks: the assets would be purchased with a significant discount and under strict conditions to stop supporting fossil fuel development. This proposal would avoid seeing European citizens pay for the mistakes of the financial industry.

To conclude, the banking sector is not prepared for the risks stemming from fossil fuels. By continuing to support oil, gas and coal companies, banks are feeding a climate crisis that could end up in a financial crisis. In a word, the vicious circle of fossil fuel finance needs to be broken. While those in power must stop betting on financial institutions’ goodwill and instead adopt strong requirements, regulators and central banks cannot continue to downplay their responsibility. Their very own mandates of financial stability require them to act on climate and they have the tools to help steer the financial system toward a Paris-aligned future.

Learn more:

• Read the full report
• Read our press release with Friends of the Earth France and the Rousseau Institute
• Read the FAQ on the report
• Read banks’ right to reply (in French)
• Download the full data set