The natural capital cost of carbon emissions associated with Chinese commercial banks’ outstanding credit to 35 sectors of the economy in 2014 totalled $1.26 trillion, according to a report by environmental consultancy Trucost.
That figure is derived from an overall environmental risk amounting to 11 trillion yuan, with emissions accounting for nearly 75% of the total, the report said.
“This significant impact should raise immediate concerns for lenders as the Chinese government has implemented various policies to internalise unpaid natural capital costs,” it said.
“Many of the sectors included in this study will either be directly regulated in the national carbon trading scheme from 2017, or face more stringent energy efficiency requirements, for example, ultra-low emission retrofits for all coal-fired plants by 2020 to support China’s pledge to cap national emissions by around 2030.”
Based on a model developed by Trucost and the Industrial and Commercial Bank of China, the report found that banks face environmental risks of 1.07 yuan for each yuan in outstanding credits to power generators, manufacturers, and land-based industries.
“The coal power generation sector alone contributed 26.1% to the overall natural capital cost of the Chinese commercial banks. This sector has the highest natural capital cost among the 35 sectors analysed in this study, as such should therefore be a priority for risk management,” the report said.
“The manufacturing industry as a whole (comprising 25 sectors) was responsible for over half of the natural capital costs analysed. The industry is already vulnerable due to the challenge of over-capacity, more stringent environmental regulations that internalise unpaid environmental costs could put the industry under further financial pressure.”
To determine the risk associated with carbon emissions, the report used $117 (2014 dollars) per tonne as the social cost of carbon, as applied by the landmark 2006 Stern report into the economic costs of action on climate change.
Prices in the Chinese national ETS are expected to open well below those levels. A government researcher told Carbon Pulse in December that the government is estimating that it needs a carbon price of around 100 yuan ($15.37) per tonne in order to meet its 2030 emission target.
But the social cost of carbon goes well beyond permit prices and also includes elements such as changes in net agricultural productivity, human health, and property damages from increased flood risk.
Trucost urged China’s commercial banks to start taking natural capital cost risks into account in their lending policies.
“For banking institutions, integrating natural capital analysis into green credit system will indicate the underlying environmental risks of future lending from an impact-based perspective. This system is currently able to account for risks of environmental incidents (non-compliance) and to limit additional credit exposure in a number of energy intensive sectors,” it said.
“For equity investors, incorporating the natural capital concept into equity research and valuation is key to minimising their risk exposure. Although they enjoy more flexibility in terms of investment strategies and sectorial preferences compared to commercial banks, natural capital risks are still relevant to diversified equity portfolios.”
The government has issued green lending guidelines, and last December the central bank released green bond rules as part of a push to mobilise the financial industry to help clean up the economy.
By Stian Reklev – stian@carbon-pulse.com
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