The growing sustainable finance market provides a path for banks to manage near-term uncertainty while capitalizing on trends that are reshaping the global economy, according to a new report from the consulting firm McKinsey & Co.
By 2030, debt-focused investment supporting climate transition around the world could offer banks revenue potential of at least $100 billion per year, the firm found in its annual global banking review.
Over the last decade, efforts to reduce emissions have focused on investments in renewable energy and the decarbonization of power generation, the McKinsey researchers wrote. They argued that the focus will widen in the coming years to include electrification, emissions reductions in energy-intensive industries and more.
"In this next era of transition, we will see continued focus on capital deployment for sustained growth in low-emission power generation," the report stated. "But we will also see many new aspects of the global energy transition being pushed as priorities — and requiring financing."
Over the last two years, the volume of so-called sustainability bonds, debt instruments that are used to finance environmentally friendly projects or social initiatives, has increased by 80% to $965 billion, according to the McKinsey report. And last year, sustainability-linked syndicated loan volume increased 200% from 2020 to $683 billion.
McKinsey estimated that lenders could facilitate $1.5 trillion in corporate investments in energy transition assets over the next eight years. But they also wrote that growth in sustainable lending, which was on a strong upward curve between 2017 and 2021, has fallen short this year. Financing for clean energy projects has totaled $76 billion through the first three quarters, down from $164 billion for all of last year.
The opportunities for U.S. banks in sustainable finance are being driven partly by the Inflation Reduction Act, which was enacted in August, according to the McKinsey researchers. The law provides government subsidies and tax credits to encourage the development of clean energy projects.
Growth in sustainable lending comes at a time when banks have been seeing their valuations sink amid economic turbulence. The sector's global market capitalization fell to $14.5 trillion in May from an all-time high of $16 trillion in 2021.
Fallout from the COVID-19 pandemic, including labor and supply-chain shortages, war and energy shortages, has ushered the banking sector into an era of economic uncertainty, the report stated.
The two tasks that banks now face are to build short-term resilience and prepare for long-term change, Miklós Dietz, a managing partner at McKinsey, said Tuesday during a press briefing. Those challenges provide banks an opportunity to "reinvent themselves" and "future-proof" their business models, he said.
"Banks need to understand how to build long-term sustainable growth," said Dietz, who leads the firm's strategy and finance group.
He added that growing public alarm about the risks of climate change and shifting perceptions about the role of financial institutions in society offer lenders a "revision of their social contract with the rest of the economy."
"For that, climate change and sustainability gives a tremendous opportunity," Dietz said.
In the near term, banks' margins and returns on equity are getting a boost from high inflation. McKinsey estimated that returns on equity will average between 11.5% and 12.5% in 2022, but they could fall to 7% by 2026 in the event of a prolonged downturn.
As central banks hike interest rates in response to inflation, banks will look to reduce rate-sensitive exposure to auto loans, mortgages and bond issuances, according to the McKinsey report.
At the same time, banks face increasing competition from fintechs with service-based business models, which will force them to expand their own digital presences in areas such as wealth management, the researchers wrote.
