Banks face penalties and legal action over fossil fuel funding

Dutch banking group ING has become the latest to come under threat of legal action over fossil fuel investment

Legal action could prompt banks to strengthen climate action or face reputational risk, according to Morningstar DBRS. This comes in the wake of Milieudefensie, the Dutch branch of climate-oriented NGO Friends of the Earth, announcing plans to take Dutch banking group ING to court over its funding of fossil fuel developments.

Milieudefensie’s case argues that ING, through its exposures, has contributed extensively to global warming. A similar case was bought last year against Shell Group, aiming to force the company to reduce their greenhouse gas emissions by 45% by 2030 in compliance with the Paris Agreement.

For Morningstar DBRS, although these cases are not expected to place the credit strength of these financial institutions in jeopardy, it could set a precedent and force banks – alongside increased regulatory pressure – to accelerate a reduction in their exposure to fossil fuel companies not aligned with the Paris Climate Agreement. Successful legal actions against them “could result in penalties and more importantly reputational damage that could affect their franchise”.

Banks facing ‘increased scrutiny’

Banks and other large companies have committed to respect the commitments agreed to via the Paris Agreement, aiming to limit global warming to 1.5°C by the end of the century in order to prevent more severe consequences from climate change.

To achieve this, signatory countries are obliged to ensure that a common goal is set and implement plans to achieve the targets, with the largest domestic companies often among the largest contributors to greenhouse gas emissions.

According to Morningstar DBRS’ Approach to Environmental, Social and Governance Risk Factors in Credit Ratings from January 2024, banks and financial institutions are facing increasing scrutiny to understand the extent to which their lending and underwriting activities contribute to climate change.

Most European banks have started adapting and already comply with commitments and initiatives such as the UN Sustainable Development Goals, UN-backed Principles for Responsible Investment or the Net Zero Banking Alliance. On top of this, they follow the guidelines put forward by the now dismantled Taskforce for Climate-related Financial Disclosures (now included within the IFRS Foundation).

Nevertheless, Morningstar DBRS pointed out banks could see more legal actions such as those threatened to be bought against ING in the future.

“Whilst we understand Dutch law creates a favourable setting to make such an outcome possible, we think there could be a similar approach taken in other jurisdictions. We also note the European Central Bank (ECB) warned in December 2023 of higher fines for banks not achieving the expected progress in managing their climate and environmental risks,” commented Morningstar DBRS.

The credit ratings agency’s vice president of global financial institutions, Arnaud Journois, added: “The reputational damage related to these cases could become relevant to the credit rating under a scenario of disorderly transition or business as usual, as the materialisation of more extreme adverse weather events could lead to customers to switch to banks perceived as more sustainable or aligned with decarbonisation. This could prompt banks to further strengthen their climate-related risk management practices and accelerate their reduction of fossil fuel financing specifically.”

ECB highlights risks of misalignment with EU climate objectives

Meanwhile, new research by the ECB shows that while net-zero commitments are mainstream for European banks, alignment to those commitments is severely lacking.

According to the report, the European banking sector shows substantial misalignment and may therefore be subject to increased transition risks, with around 70% of banks also subject to elevated reputational and litigation risk. Such misalignment can be seen in the overextension of credit and financing to high emitters, large financing given to non-net-zero aligned corporates and insufficient action on fossil fuel phase outs.

The report goes on to say that misalignment poses transition risks that will be exacerbated in a disorderly transition, alongside policy-related risks, reputational risks and legal risks for those failing to meet their commitments.