Julien Froumouth is a sustainable finance advisor at the Luxembourg Bankers’ Association (ABBL) and Thomas Verhagen is the founder of WeESG, which gives training and advisory services in sustainable finance.

Both experts spoke about the role of banks, and financial institutions more generally, in the green transition of the real economy. From the interviews, a few moments emerged as being key parts of this larger movement.

Transition finance

One area of sustainable banking that is underacknowledged, says Froumouth, is transition finance. This amounts to the regulation, roadmaps, standards and best practices associated with turning “brown” companies into “green” ones. “We have a taxonomy for green activities,” the adviser points out, “but not for the ones that are in transition.”

“We need to support the broader range of economic projects or companies in their transition, including those companies operating in carbon-intensive or more sensitive sectors,” he says, pointing out that if all the funding goes into solidly “green” companies then a substantial part of the problem will remain unaddressed.

For example, the construction industry. This sector alone accounts for 20% of Luxembourg’s carbon emissions and–especially given a new EU directive on energy performance that requires all buildings to have net zero emissions by 2050–is one in which transition finance will be crucial.

“We have a lot of old buildings [in Luxembourg] that need urgent transitions,” says Froumouth, adding that the ABBL is currently discussing how banks, as the main source of funding for buyers and renovators of buildings, can be of support–particularly for the worst-performing ones. Challenges could include sourcing material and expertise, as well as credit risks (given a potential correlation, though not yet a proven one, between low-performing buildings and low-income earners).

Banking/insurance crossover

Speaking of risks, Verhagen draws attention to those more immediately caused by climate change. The relationship of risk management to sustainability is changing, he says, to the point where threats to biodiversity and the climate will–in the eyes of supervisors and regulators–influence all other types of risk.

“Sustainability used to sit, for many years, in the domain of reputational risk,” he says. “That’s gone. That doesn’t exist anymore.” Among others, physical risks like the impacts of floods and droughts need to be anticipated and disclosed.

As an example, he cites how low water levels in the Rhine have affected the German transportation industry, or how the disturbance of water cycles in Brazil has led to local hydropower shortages, with trickle-down effects for internet companies that can’t get enough electricity and so need to pay to get more of it, which, in turn, affects their financials.

“These types of cascading effects… feed into credit risk, into operational risk, into market risk and potentially into liquidity risk.”

On 20 March, a new partnership between the Spuerkeess and the Luxembourg Institute of Science Technology (LIST) was announced: LIST will build a database of flood hazard maps that Spuerkeess customers can use to make better-informed decisions.

“I think that’s a very prudent approach,” says Verhagen of the partnership.

Going further, he wonders how such risks can be handled in the future. Citing his former experience in banking, he reports that bankers used to say that if things really went wrong then there was always the insurance. But now that model is under threat. “Imagine a world in which [insurance] was not a given. All of the sudden, it becomes thinkable that these fundamentals of a business model or a way of doing in a sector, or an industry, or a country… change.”

As one answer, he foresees more crossover and collaboration between the banking and insurance sectors: “I think that might be something to consider when looking ahead.”

Client conversations

How banks speak to clients is also evolving, says Verhagen. The policy, technology and consumer landscapes are changing, and sometimes rapidly, which makes a unique environment in which banks need to help and advise their clients. As always, opportunities need to be discussed, he says–but so might financing needs for the client (capital or operating expenditures, working capital needs, etc.) or even risks to the bank itself.

“It’s increasingly being recognised within the sustainable finance space… that this kind of stuff is going to be very important,” he says. If the old model was to have a bank employee pushing out sustainability reports and staying updated on frameworks, the new model is “a democratisation of these types of engagements, albeit on a less technical level, towards the front office and risk management.” In other words, more communication.

Outreach and public engagement

On a related note, Froumouth stresses the importance of educating the general public about sustainable banking. “Part of bank obligations now is to collect the sustainability preferences of their clients,” he says, adding that the subject tends to be closely linked to personal values. Individuals’ priorities can range widely, he says, from human rights to biodiversity to other issues, which creates challenges with communicating complex ideas and instruments. “You have to offer products that are compatible with those preferences. And it’s very difficult to explain those complex issues in very basic terms.”

Indeed, people often want to keep their binary understanding of sustainable financing, he says, i.e., that money goes either to green (good) projects or brown (bad) ones. “You have to make it understandable that ESG is not that narrow.”

Establishing a way of clarifying the jargon and complex language is, for Froumouth, a major challenge not only for banks but for financial institutions in general. And he brings this back to the more fundamental role of the sector: “As financial intermediaries, we [banks and financial institutions] have to support the entire economy.”

Transition of the real economy

Which brings us to one final point made by both of the experts, already present in several of the comments quoted above: the role of banks in the green transition of the real economy.

“The main policymakers see the financial sector as a driver of the transition of the real economy,” says Verhagen, noting that European Green Deal was accompanied by the European Sustainable Finance Strategy. “It’s a bit of a chicken and egg question, of course. But one of the things we see emerge more and more is the engagement between financial institutions, particularly banks, and real economy clients.”