Managing Financed Emissions: How Banks Can Support the Net-Zero Transition

Banks play a crucial role in financing both carbon-emitting businesses and decarbonization efforts across the global economy. Their approach to managing financed emissions—the emissions associated with their lending and investment portfolios—determines their contribution to climate change mitigation. Over the past few years, many banks have committed to reducing their financed emissions in line with the Paris Agreement, but achieving this goal is complex and requires a structured, data-driven approach.

To effectively transition toward net-zero emissions, banks must measure, manage, and mitigate climate-related risks. Indonesia has introduced through the Otoritas Jasa Keuangan (OJK) a guideline titled Climate Risk Management & Scenario Analysis (CRMS) Guidelines, providing a structured approach for banks to integrate climate risk into financial decision-making. The OJK’s CRMS Guidelines (2024) provide a structured approach for banks to:

1. Assess climate risks in their lending and investment portfolios.

2. Develop strategies to mitigate financial exposure to climate change.

3. Disclose emissions data to promote transparency and investor confidence.

The launch of IDX Carbon, Indonesia’s carbon trading platform, further supports green financing, enabling banks to invest in emission reduction projects while maintaining financial stability.

Banks financing high-emission industries face a few challenges, this includes Reducing Financed emissions and Continuing to provide capital to companies for their decarbonization efforts. To manage these problems, a bank must navigate the varying emissions profiles and transition pathways between borrower industries, data gaps in the emission data, regulatory complexity, and business tradeoff between the bank emission reduction and its revenue growth.

The Six-Step Process for Managing Financed Emissions

1. Measuring the Financed Emissions Baseline

Banks must first establish an emissions baseline, which serves as the foundation for climate risk management. This will be done by calculating the total emission using the GHG Protocol, PCAF, and ISO14064-1. This includes:

• Sector Coverage: Prioritizing high-emitting industries (e.g., oil & gas, power generation, automotive, mining).

• Asset Classes: Assessing various financial products (e.g., corporate loans, real estate investments, project finance).

• Scope of Emissions: Including Scope 1 (direct emissions), Scope 2 (indirect energy-related emissions), and where relevant, Scope 3 (value chain emissions).

2. Projecting the Portfolio’s Momentum Case

Banks need to build a momentum case to predict how financed emissions will evolve under current financing patterns. This includes:

• Counterparty Analysis: Understanding emissions reduction commitments from high-impact clients.

• Sectoral Trends: Forecasting industry shifts based on regulatory changes, technology advancements, and energy transitions.

• Scenario Planning: Assessing best- and worst-case scenarios for emissions reduction.

Indonesia’s CRMS guidelines emphasize this step by requiring banks to use macroeconomic and disaster data to project the financial impact of climate risks.

3. Selecting a Reference Scenario

Once the baseline and momentum case are established, banks must define a net-zero pathway by aligning with recognized climate models. These include:

• Intergovernmental Panel on Climate Change (IPCC) Scenarios

• International Energy Agency’s (IEA) Net-Zero Roadmap

• Network for Greening the Financial System (NGFS) Models

Each scenario outlines sector-specific emissions reductions needed to stay within a 1.5°C global warming limit. In Indonesia, OJK’s CRMS framework encourages banks to align with local carbon trading mechanisms and climate regulations.

4. Determining How to Achieve Net-Zero Goals

Banks must identify practical steps to reduce emissions while continuing to support economic growth. Key strategies include:

• Green Financing: Increasing investments in renewable energy, electric vehicles, and sustainable infrastructure.

• Client Engagement: Encouraging high-emitting clients to adopt emissions reduction strategies.

• Portfolio Rebalancing: Shifting capital allocation toward low-carbon sectors.

• Technology Investments: Supporting the commercialization of decarbonization technologies.

Indonesia’s OJK Regulation No. 14 of 2023 complements these efforts by establishing IDX Carbon, a carbon trading exchange that enables financial institutions to support carbon offset projects.

5. Setting Financed Emissions Targets

Once a pathway is defined, banks set clear and measurable targets to track their progress. Target-setting involves:

• Absolute Emissions Reduction: Aiming for a lower total carbon footprint.

• Emissions Intensity Reduction: Lowering emissions per unit of financing (e.g., CO₂ per $1M loan).

• Sectoral Targets: Creating specific goals for high-emission industries.

• Financing Mix Adjustments: Balancing traditional lending with climate-aligned financing.

Indonesia’s CRMS framework mandates climate risk disclosures, ensuring that banks transparently report their emissions reduction progress.

6. Embedding Execution into Bank Operations

To ensure long-term success, banks must integrate climate objectives into daily operations and corporate strategy. This involves:

• Credit Policies: Incorporating emissions metrics into loan approvals and risk assessments.

• Incentives & Training: Aligning banker incentives with climate goals and upskilling employees in sustainable finance.

• Regulatory Compliance: Preparing for evolving disclosure requirements and regulatory frameworks.

• Data Infrastructure: Improving emissions tracking capabilities through digital solutions and third-party verification.

Indonesia’s OJK Regulation No. 17 of 2023 requires commercial banks to embed climate risk management into governance structures, ensuring that financial institutions actively mitigate climate-related risks while supporting sustainable investments.

Indonesia’s Leadership in Climate Risk Management

Indonesia has emerged as a leader in climate-aligned banking regulations, integrating Climate Risk Management & Scenario Analysis (CRMS) into its financial sector. The OJK’s CRMS Guidelines (2024) provide a structured approach for banks to:

1. Assess climate risks in their lending and investment portfolios.

2. Develop strategies to mitigate financial exposure to climate change.

3. Disclose emissions data to promote transparency and investor confidence.