Green Asset Ratio: managing expectations

The primary objective of the Grenn Asset Ratio (GAR), established under the Article 8 Delegated Act of the EU Taxonomy Regulation (2020/852), was to help stakeholders understand financial undertakings’ contribution to European environmental and climate objectives. However, while the Green Asset Ratio is a step towards improving transparency, it will not tell the story of the transition efforts of banks and only have limited information and decision-making value.

In principle, the GAR is a simple ratio of EU Taxonomy-aligned assets as a percentage of total covered assets. While it may be tempting to look at it as a simple metric to understand the sustainability of banks, it will only show a small portion of banks’ efforts to finance transition.

For example, a bank can be making significant progress in helping polluting clients reduce their environmental impact, which will in most cases not be reflected in the GAR. An investment in green government bonds also does not lead to a higher GAR as sovereign exposures are excluded from the calculation. Similarly, the financing of a renovation loan for a building with low energy efficiency will not be reflected in the GAR unless a high energy efficiency level is achieved after the renovation. Financing solar panels for a local bakery will also not be considered taxonomy aligned for the purpose of the GAR, nor will financing of an enterprise outside the EU. This is due to the asymmetry between the scope of the numerator and the denominator of the GAR. Except for exposures to sovereigns, that are excluded symmetrically, the rest of these exposures count towards the denominator but not the numerator of the GAR. Financing to SMEs that are not obliged to report under the NFRD/CSRD or to non-EU companies can therefore never qualify as EU Taxonomy aligned. Furthermore, activities that aren’t covered by the EU Taxonomy will also be excluded from the numerator but not the denominator.

These structural features of the GAR will lead to divergence in the value of the green asset ratio, depending on a bank’s business model, client-base and geographical footprint. A simple comparison of GAR numbers between banks could therefore be misleading. Banks financing SMEs and clients in third countries will show structurally lower green asset ratios compared to banks predominantly financing large undertakings – the higher the financing to SMEs and non-EU companies, the lower the ratio.

The GAR comparison will be further hampered by the large room for interpretation and by the difficulties in assessing and documenting Taxonomy alignment, both by corporates and banks. Banks find it particularly challenging to document the energy performance and DNSH criteria of real estate in their mortgage and car loan portfolios. It is not realistic to assume that banks will obtain evidence on the Taxonomy compliance directly from the clients or via verification from a third party. Homeowners do not necessarily possess the required information. EPC certificates are largely unavailable, outdated or do not contain the necessary information. As it is not possible to rely on non-documented information or assume that DNSH criteria are met under the EU law, the financing of electric cars or mortgages are in many instances not going to be included in the GAR.

Apart from the lack of data and documentation, there is also confusion on how certain Taxonomy criteria must apply. The approaches taken by individual companies depend on interpretation and the degree of conservatism. The divergent approaches envisaged will have a major impact on the ability to compare GARs.

The overall expectations on the GAR and its information value therefore have to be managed as GAR numbers of banks will be hard to compare. In addition, GARs are expected to be low as they will reflect the performance of economic activities in the EU as well as the ability of companies and households to document the alignment with the EU Taxonomy, even on activities that are generally considered green. The Association of German Banks’[1] analysis of the taxonomy profile of 450 corporates concludes that the EU industry is largely still at the beginning of its transition. Only 7% of the analyzed corporates’ turnover currently fulfils the taxonomy’s technical standards.

To conclude, GARs should not be compared without understanding the context and other relevant information on banks’ efforts to finance transition. Additional metrics disclosed in the GAR templates need to be analyzed to understand the portfolio composition of financial institutions and the GAR itself as several methodological particularities of GAR may impact its value. While the GAR may be complemented by additional voluntary reporting where a ratio on SMEs and Non-EU exposure Taxonomy alignment can be shown separately, the data to assess the alignment is not necessarily available and could be estimated at best.

It is important that the banking sector not only finance activities that can already be considered EU Taxonomy aligned, but also activities that are performing at different levels and which can accelerate companies’ transition.

Decisions cannot be made purely based on Taxonomy-related disclosures of companies. Not having Taxonomy-aligned activities does not in itself reveal the company’s exact environmental performance. Instead, other disclosures, such as the company’s disclosures under the CSRD will help inform markets about the company’s environmental performance and the company’s direction of travel.

Given the methodological shortcomings of the GAR and the practical usability issues, the planned revision of GAR in 2024 is welcome. However, the GAR will always be limited to Taxonomy alignment and will need to be complemented with other information to understand the progress of the financial sector.