Study prompts calls for fossil fuel capital requirements

A new study has found that a substantial stranding of fossil fuel assets is necessary if the Paris Agreement target is to be met, prompting civil society organisations to call for risk weighting and other capital requirements to be introduced for bank fossil fuel exposures.

The University College London study, published last week in the science journal Nature, uses a global energy systems model to show that nearly 60% of all oil and fossil gas reserves and 90% of coal reserves must remain in the ground to allow for just a 50% probability of limiting global heating to 1.5 °C. This would mean a huge write-down in the value of fossil fuel companies, with associated risks for lenders.

“This new study confirms that fossil fuel exposures will diminish rapidly in value or even become worthless as the underlying assets have to remain in the ground to meet the Paris climate goals,” Benoît Lallemand, secretary general of Finance Watch, told Green Central Banking in response to the study’s release. “Financial institutions, however, keep financing and insuring fossil fuel extraction on a large scale. This will result in massive losses they won’t be able to absorb without taxpayers’ support.”

Calling on financial regulators to increase capital requirements for fossil fuel exposures, Lallemand said that such exposures should be funded out of equity. “This would ensure financial firms absorb the full extent of potential losses – a basic risk management principle for high risk exposures,” he said.

Following an International Energy Agency report calling for an immediate end to all investments in new fossil fuel projects, Finance Watch proposed a 1250% risk weight for bank exposures to new projects exploiting fossil fuel reserves to reflect both the microprudential and macroprudential risks of such projects. A subsequent proposal from eight civil society groups called for similar capital requirements.

Gregg Gelzinis, associate director for economic policy at American Progress, also responded to the Nature paper, warning that financial institutions could face large losses as fossil fuel reserves are stranded in the low-carbon transition.

“The research is increasingly clear: a significant portion of fossil fuel reserves cannot be extracted if the world is to stem the climate crisis and keep warming to 1.5C,” he said.

“It is critical for financial regulators to take a precautionary approach and proactively mitigate the risks associated with the worst climate outcomes,” he added. “Applying substantially higher capital risk weights to carbon-intensive exposures, with a special emphasis on new fossil fuel investment, would meaningfully improve the resilience of the financial system to the risks posed by climate change. It would also ensure the financial system is in a position to better support the real economy during the transition to net zero.”

The Basel Committee on Banking Supervision has recently proposed a 1250% risk weight against cryptoassets, requiring that all investment by financial institutions in these assets must be funded through their own equity. Civil society campaigners have proposed that a similar 1250% rule be applied to all new fossil fuel expansion and exploration.