The financial sector comprises institutions and markets that provide financial services to commercial and retail customers. It holds significant influence in low-carbon transition and decarbonization by expanding capital towards low-carbon activities and withdrawing from high-carbon activities (Paris Agreement, Art 2c). While the finance sector’s own emissions are relatively small, its indirect and financed emissions are huge. According to the United Nations Environmental Program (UNEP), the financial sector contributes to over 60% of GHG emissions globally due to its own operation along with its financing activities. As per the Paris Agreement, to keep global warming well below 2°C, the emissions need to be reduced by 45% by 2030 and reach net zero by 2050.

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Despite the goals set by the Paris Agreement, the flow of capital seems misaligned. According to an article by The Guardian, over $7tn have been lent by world’s bank to fossil fuel industry ever since the Paris Agreement. The emissions from lending, investing and underwriting are 700 times higher than the financial sectors own operational emission (CDP, 2021). Thus, the financial institutions have the power to finance the low-carbon projects. Aligning the financial system with the net-zero target is essential for achieving decarbonization and the goals of the Paris Agreement.

Measuring Finance-Driven Emissions

Emissions from the financial sector can be categorized into operational emissions and financed emissions. The operational emissions are internal emissions due to purchase of electricity for office use, and combustion of fuel in company-owned vehicles. They also include indirect emissions across value chains like purchased goods and services, business travel, employee commute, waste, etc.

The financed emissions fall under category 15 of the Scope 3 emissions; it represents greenhouse gas (GHG) emissions associated with company investment and financial activities. They are calculated depending on the value of investment or portfolio in the companies that generate GHG emissions. According to research by Danmaks National Bank in 2024, the financed emissions from the sector have increased by 1.4 million tonnes experiencing a 13% rise from 2023. Despite the significance, disclosure of financed emissions is limited. In CDP’s first financial services climate change questionnaire in 2020, only 25% of the 332 financial institutions reported portfolio emissions, underlining gaps in measurement and transparency.

Key Driver for Decarbonization in Financial Sector

There are several factors pushing for the decarbonization of the financial sector including regulatory pressure, growth of sustainable finance market, climate-related financial risk, and demand for sustainable products from the customers.

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The TCFD had provided a voluntary framework for companies to report material climate risk in 2017 and recommended disclosing information on management’s role in climate-related risk, scenario analysis, etc. The IFRS S1 and IFRS S2 launched by the International Finance Standard aims to establish a global benchmark to provide information on ESG related risk and opportunities. The standards mandate companies, including financial institutions, to disclose climate-related risk and opportunities, strategy, risk management along with metrics and targets.

The European Banking Authority (EBA) has made mandatory disclosures for banks to report climate and transition risks and plans to address the risks. The Green Asset Ratio (GAR) and the Banking Book Taxonomy Alignment Ratio (BTAR) were introduced by the EBA to provide information on the extent to which the institution’s portfolio is in line with EU Taxonomy.

The global push towards reporting the risk is increasing the number of companies along with financial institutions to report climate-related data. This increases the pressure on financial institutions to measure, manage, and report climate impact along with financed emissions.

Frameworks Driving Net-Zero Finance

The standards and framework such as the Partnership for Carbon Accounting Framework (PCAF), The Greenhouse Protocol and the Science Based Targets initiative (SBTi) play an important role by guiding financial institutions on the way to measure, manage and reduce emissions associated with lending and investment portfolio.

The Partnership for Carbon Accounting Framework (PCAF) is a worldwide partnership of financial institutions that aim to develop and execute a harmonized approach to measure and report GHG emissions associated with loans and investments. It provides methodology for calculating financed emissions from asset classes such as listed equity & corporate bonds, business loans and unlisted equity, project finance, mortgages, commercial real estate and motor vehicle loans. It recognizes the role on financial sector to bring change and move towards low-carbon society aligning with the goals of Paris Agreement.

The Greenhouse Protocol is an international standard for corporate accounting and reporting emissions across Scope 1, 2 and 3 based on the source. It is a joint initiative of the World Resource Institute (WRI) and the World Business Council for Sustainable Development (WBCSD). The protocol mandates Category 15 emissions to financial institutions as financed emissions contributes the largest part to GHG footprint. The financial institutions should allocate emissions based on the share of investment. The protocol recommends using the methodology and approach by PCAF to calculate the financed emissions.

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The Science Based Targets initiative (SBTi) is an international organization that guides companies and financial institutions to set science-based targets. The SBTi defines financial institutions as an organization that generates 5% or more revenue from investment, lending or insurance activities It launched the Financial Institutions Net – Zero Standard to align the financial institutions with pathways to limit the global warming and achieve net-zero emissions by 2050. The standard provides guidance and criteria to financial institutions to set both near-term and long-term targets.

Strategies for Decarbonizing the Financial Sector

For decarbonization of finance sector various strategies can be implemented such as sustainable finance – directing financial resources away from fossil fuel and carbon intensive sectors to low-carbon, sustainable sectors like renewables, sustainable infrastructure and clean energy. According to World Investment Report 2025 in 2024 the sustainable finance market grew to over $8.2 trillion, showing an increase of 17% from 2023.

The financial institutions should also prioritize internal decarbonization to address operational footprint from electricity consumption in offices, data centers, etc. This can be achieved with green electricity, enhancing the operational efficiency and switching to hybrid or electric vehicles.

Related Read: Financial Blueprint for Building Decarbonization: Tools and Strategies

Integration of climate-related risk and ESG criteria in the credit risk assessment, risk management and due diligence will help financial institutions avoid high-carbon and high-risk projects and support investment to low-carbon projects. A study by Andre etal. on corporate bond portfolios found that sustainable portfolios (with ESG screening) had lower credit risk exposure than non-sustainable peer portfolios. Thus, ESG screening can lead to lower default risk and good credit performance while supporting sustainable finance roadmap.

Conclusion

According to the World Investment Report 2025, global sustainable bonds (green, sustainability, social and sustainability-linked) market reached $1,052 billion in 2024, which shows the proceeds of the capital towards low-carbon and sustainable investment is increasing rapidly and driving the transition to green finance and low-carbon economy. With the expansion of the sustainable and green finance market along with regulatory and investor pressure, financial institutions have a significant opportunity to work towards transitioning to low-carbon future and achieve decarbonization.

To achieve this, financial institutions will have to align portfolios, drive internal decarbonization, integrate ESG risks in decision making and scale sustainable finance solutions to accelerate the global decarbonization efforts and build a resilient and sustainable economy.

Why Choose Ascentium?

At Ascentium, our team has extensive expertise across sectors including power, cement, steel, chemicals, textiles, and the financial sector in driving decarbonization. We provide comprehensive, end-to-end solutions from data collection, boundary setting, GHG inventory preparation to emissions quantification, identification of reduction opportunities, and the development of tailored, policy-aligned decarbonization roadmaps. Our approach transforms regulatory requirements into strategic advantages, further supported by strong capabilities in content development for stakeholder disclosures and green financing engagements. To learn more about our services, write to us at info@incorpadvisory.in or reach out to us at (+91) 77380 66622.

Source:

Authored by:

Prakhar Gupta | ESG and Sustainability

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