Starting in 2024, a significant change is underway in sustainable finance, as European banks are now required to report their Green Asset Ratio (GAR). This newly mandated Key Performance Indicator (KPI) is set to transform transparency and accountability within the banking sector. By shedding light on the proportion of a lender’s assets actively financing activities aligned with the EU Taxonomy’s definition of sustainability, the GAR can reshape how banks approach and report on their green investments.
What is the Green Asset Ratio?
As we were saying, the GAR measures a bank’s commitment to sustainability by quantifying the portion of its assets dedicated to financing activities aligned with the EU Taxonomy’s criteria.
Despite its seemingly simple formula – the sum of Taxonomy-aligned assets, including loans, bonds, and other financial instruments that finance environmentally sustainable activities, divided by the bank’s total assets – implementing the GAR poses several challenges.
⇒ EU Taxonomy Alignment: determining whether financial activities qualify as “sustainable” under the EU Taxonomy’s strict criteria requires meticulous assessment and comprehensive data analysis. This technical screening process demands the examination of each financed activity’s environmental impact, a task that demands expertise and extensive data analysis. The challenge is particularly pronounced for loans to corporate customers, where obtaining granular data on the specific activities financed can be difficult. The lack of standardized reporting formats and data gaps further complicate the assessment process, making it a time-consuming and resource-intensive endeavor for financial institutions.
⇒ Existing Loan Portfolios: evaluating the sustainability of existing loan portfolios remains a significant burden. As banks struggle with assessing the sustainability of their existing assets, developing a standardized approach for incorporating them into the GAR calculation is an ongoing challenge that necessitates innovative solutions and industry collaboration. While the GAR initially focuses on new loan applications, including existing portfolios is indeed a demanding affair.
The potential and limitations of the GAR, as highlighted in reports by the European Banking Authority (EBA) and the European Banking Federation (EBF), will be explored further in a subsequent section of this article.
The connection between the Green Asset Ratio, the EU Green Bond Standards and the EU Taxonomy
The European Green Bonds, often abbreviated as EuGBs, adhere to a uniform set of standards outlined in the EU’s regulatory framework. These bonds are designed to finance or re-finance sustainable projects and activities. The proceeds from these bonds must be fully allocated to projects that align with the EU Taxonomy for sustainable economic activities.
To ensure transparency and credibility, the issuance of European Green Bonds is subject to strict requirements, including pre- and post-issuance external reviews. These reviews evaluate the alignment of the bond’s use of proceeds with the EU taxonomy and the impact of the financed projects.
The European Green Bonds are a key instrument in the EU’s efforts to mobilize sustainable finance and support the transition to a greener economy. They provide investors with a way to invest in environmentally sustainable projects, while also helping issuers to raise capital for their green initiatives.
In summary, if the EU Taxonomy provides the foundation for defining sustainable economic activities, the EU Green Bond Standard ensures that bonds labeled as “green” are financing projects aligned with the Taxonomy, and the Green Asset Ratio is a metric used to assess the proportion of green assets held by financial institutions. These three elements are interconnected and work together to promote sustainable finance and support the transition to a more sustainable economy in the EU.
Potential and limitations of this new KPI
The Green Asset Ratio, as outlined by the European Banking Authority (EBA), offers significant potential in advancing sustainable finance. For example, to increase transparency, by standardizing information on the environmental performance of banks’ assets, helping stakeholders to better understand alignment with sustainability goals. The GAR can make banks’ impacts, including green loans, more visible, encouraging greener practices, increasing sustainable activities, and stimulating the development of new sustainable financial products and services, while supporting the transition to a low-carbon economy by encouraging green lending and investments.
Meanwhile, investors can utilize the GAR to evaluate the sustainability of financial institutions, making it theoretically easier to compare banks’ environmental performance.
If in theory, the GAR is a substantial step forward for greener banking, it also has some clear limitations. In that sense, the European Banking Federation (EBF) analyzed the following issues:
- Limited scope: the GAR does not cover a large part of the economy financed by banks, including 99% of European SMEs and non-EU counterparties.
- Asymmetry: the GAR’s calculation is asymmetrical, as exposures to SMEs and non-EU companies are included in the denominator but not the numerator, artificially lowering the ratio.
- Misleading comparisons: the structural features of the GAR can lead to misleading comparisons between banks with different business models and client bases.
- Implementation challenges: assessing and documenting the EU Taxonomy alignment can be complicated, particularly for retail clients and use-of-proceeds financing.
- Limited information value: the GAR is a snapshot of the current state and does not reflect the transition progress of banks or companies. It should not be the sole metric for evaluating sustainability performance.
From this short overview, there seems to be room for improvement, and changes by the European Commission to reassess the composition of the GAR might happen in the near future. But it also seems to be an important starting point and financial institutions are required to organize to identify processes to assess their investments.
Leveraging AI to streamline EU Taxonomy reporting: a practical solution for banks
Given the complexities of assessing and classifying financial activities as “sustainable” under the EU Taxonomy, banks are increasingly turning towards innovative solutions like artificial intelligence (AI). AI-powered tools can streamline and enhance compliance processes in the context of the EU Taxonomy and consequently also for the GAR calculation and reporting. Leveraging machine learning (ML) algorithms and natural language processing (NLP) can efficiently help analyze vast amounts of data to assess alignment with the EU Taxonomy criteria.
Several German financial institutions have already adopted AI-powered solutions to simplify their EU Taxonomy reporting processes. Notably, TAXO TOOL has been expressly designed by us at Dydon AI in collaboration with the Association of German Public Banks(VÖB) and its subsidiary VÖB-Service, to satisfy the European banks’ specific needs.
TAXO TOOL has been adopted by BayernLB, NordLB, SaarLB, LBBW, and numerous savings banks through the agreement with DSGV – German Savings Banks Association, such as Sparkasse Bremen, Frankfurter Sparkasse, Hamburger Sparkasse, Sparkasse Mainfranken just to mention some, and Oldenburgische Landesbank (OLB). Through a partnership with vdpResearch GmbH, the TAXO TOOL can be used also by Pfandbrief banks, credit cooperative institutions, private banks, and independent property valuers.
As European banks continue their journey toward a more sustainable future, AI has emerged as an invaluable ally. By embracing this technology, alongside the irreplaceable value of human expertise, financial institutions can confidently navigate the intricacies of the EU Taxonomy, ensuring compliance and accelerating the transition to a greener economy.
