Ever since a short clause in the 2015 Paris Agreement called for private funding to support a reduction in global greenhouse gas emissions, the role of the finance sector in delivering climate action has been subject to increasing scrutiny.

Today, so many of the world’s biggest banks and assets managers have promised to reach net zero that one would think these financial firms would go most of the way to covering the price tag for decarbonising the global economy.

But that type of optimism is both wrongheaded and dangerous, according to the Institute of International Finance (IIF), an industry group which counts the likes of BlackRock Inc, Goldman Sachs Group Inc and UBS Group AG as members. It just published a corrective of what it sees as harmful misunderstandings.

For the past few years, policymakers, regulators and civil society have espoused what the IIF calls a “finance-centric theory of change” for delivering the energy transition. The assumption has been that if banks’ loan books and fund managers’ portfolios are aligned with a net-zero future, the required decarbonisation of the global economy will naturally follow.

This view “significantly overestimates” the capacity of banks, insurers and asset managers to influence the actions of clients and counterparties, the IIF counters. This fallacy has developed in part due to a sense of “despair” about the lack of political will from governments to address global warming, according to Sonja Gibbs, head of sustainable finance at IIF and lead author of the paper.

Some people argue that “the G20 isn’t going to be able to agree on any international framework to address this very global problem, nor will there be internationally consistent regulation to address it,” Gibbs said in an interview. “Therefore, the only agent of change that these groups can see that can really make the transition happen is the financial sector.”

The IIF paper, published this month, forms part of a wider effort by the finance industry to redefine its perceived role in the transition. Instead of indicating that the money required to green the economy is ready to flow, industry leaders now say their first priority is delivering financial returns for clients-and that means energy-transition investments will only be undertaken if they’re considered profitable.

“Expecting banks collectively to rapidly reallocate their portfolios may not be compatible with maintaining a profitable, diversified business model,” the IIF said. “It also neglects the reality of a bank’s commercial relationships, considering that banks can’t force clients or counterparties to take finance for certain activities.”

The industry initiative to back away from any “white knight” role comes amid withering fire over its continued funding of Big Oil and further fossil fuel development. Banks and investors are being assailed by activists as well as central bankers for not moving fast enough to address accelerating global warming. Financiers should take a prominent role in helping decarbonise the global economy, said Jeanne Martin, head of the banking program at environmental non-profit ShareAction. They shouldn’t be allowed to sit back and wait for governments to act, she said.

“While it’s unrealistic to expect them to do this single-handedly, there is significant potential for them to do much more right now,” Martin said.

As an organisation that represents the interests of the world’s biggest financial institutions, the IIF contends it’s not only non-profits that have misguided notions about what the industry can do, it’s also the regulators.

An area of particular concern for the IIF is what it calls the numerous, unconnected regulatory approaches to transition finance. Specifically, the issue centres on how the financial sector should support the greening of carbon-intensive sectors.

“When there are multiple sets of rules of the road, cars may start to crash into each other,” said Jeremy McDaniels, the IIF’s deputy director of sustainable finance.

Another issue, the group says, is the understanding around how transition finance will in the short term worsen the key metric stakeholders use to assess the financial industry’s contribution to meeting climate goals. That yardstick is the amount of emissions enabled by lending and investing.

The Wall Street group says debate needs to be reset to establish what Gibbs calls a “clearer understanding about the respective roles that each part of this ecosystem has to play.”

As it turns out, some of Wall Street’s biggest banks may be underestimating a risk metric that shows how they’ll fare in a world that’s rapidly being transformed by higher temperatures, extreme weather shocks and soon-to-be obsolete business areas.

While banks have started measuring climate risks, they aren’t adjusting their businesses to address the physical disruptions ahead as clients and the wider economy get hit, according to a study by Climate X, a risk data provider.

“The reason we fell into the recession of 2008” is because “we didn’t capture liquidity risk enough and the associated capital challenges that we had,”says Kamil Kluza, Climate X’s chief product officer.

Back then, “we used to pick up credit risk, operational, market risk, but we never looked at particular liquidity risk.” There’s currently a similar blind spot around climate risk, Kluza said.

  - Bloomberg