Understanding Financed Emissions: Why They Matter for Banks

Global climate change mitigation and adaptation has seen the global spotlight for the past few years. This focus is also heightened by the news of several large banks backing out from the Net Zero Pledge. Banks are not the only firm that has a large contribution, but also the other financial institutions, such as  banks, asset management firms, insurance companies and private equity firms. While it seems that financial institutions dont have as much emission as companies in the Coal, Mining, or Manufacturing, they in fact have a significant part through their financed emissions.  Financed emissions, primarily categorized as Scope 3 (Category 15) emissions, represent the indirect carbon footprint of financial institutions. These emissions result from loans and investments in carbon-intensive industries. As regulatory frameworks tighten and investor scrutiny increases, banks must address these emissions to mitigate financial and reputational risks.

What Are Financed Emissions?

Financed emissions refer to the GHG emissions linked to the activities and businesses that banks finance through loans, investments, and underwriting services. Unlike operational emissions (which come from a bank’s own activities, such as office energy use and business travel), financed emissions often make up the vast majority of a bank’s total carbon footprint.

The Partnership for Carbon Accounting Financials (PCAF) has developed a standard framework for financial institutions to measure and disclose their financed emissions. These emissions are categorized under Scope 3 emissions, as they are indirect emissions resulting from a financial institution’s value chain. The PCAF categorized each loans, investments, and services into, several categories, including:

• Listed Equity and Corporate Bonds

• Business Loans and Unlisted Equity

• Project Finance

• Commercial Real Estate

• Mortgages

• Motor Vehicle Loans

• Sovereign Bonds

The process of calculating and tracking financed emissions involves multiple complexities. Starting from differences between sectors, data availability, the unique business model and value chain of each borrower. Furthermore, the actions that banks take to achieve targets often create pressure on other objectives, such as revenue growth in critical business areas, and require changes to key processes and policies, including its credit risk analysis—a situation that calls for careful reconciliation. Finally, banks must balance their goal of reducing financed emissions with the simultaneous goal of financing reduced emissions—which often involves increasing financing to responsibly heavy emitters who need capital to decarbonize their businesses.

Why Do Financed Emissions Matter for Banks?

• Regulatory and Compliance Pressures
  Governments and international organizations are tightening climate regulations. Many jurisdictions now require financial institutions to report their climate-related risks and carbon footprints. Standards such as the Task Force on Climate-related Financial Disclosures (TCFD) and the International Sustainability Standards Board (ISSB) are shaping disclosure requirements worldwide. In Indonesia, banks are required by POJK 17/2023: Penerapan Tata Kelola bagi Bank Umum to manage its climate-related risks by using the Climate Risk Management & Scenario Analysis set by the OJK.

• Reputation and Stakeholder Expectations
  Investors, customers, and advocacy groups are demanding greater transparency and accountability. Banks that fail to measure and manage their financed emissions risk reputational damage and could lose clients who prioritize sustainability.

• Risk Management and Financial Stability
  Climate change poses physical risks (e.g., extreme weather events) and transition risks (e.g., policy changes, market shifts) that could impact loan repayment rates and asset values. By assessing financed emissions, banks can identify high-carbon exposure and integrate climate risks into their risk management frameworks.

Alignment with Net Zero Commitments
Many banks have pledged to achieve net zero emissions by 2050, in line with the Paris Agreement. Achieving this target requires banks to steer capital towards low-carbon projects and reduce financing for high-emission industries.