Green Banking in the US: Perspectives and Trends

By Nikita Belavin and Solveig Schellenberg, Sciences Po—Reims

Sep 16, 2024

Green banking, particularly in the United States, has emerged as a central approach towards intertwining economic pursuits with environmental sustainability. However, defining green banks proves to be a nuanced task, often tied to broader concepts of ethics and sustainability. Generally, green banks are part of ethical banks which means trying to include social aspects into their economic pursuits (San-Jose et al., 2011, p. 151). Yet the exact understanding of what constitutes "green" in a bank remains diffuse due to the absence of standardized labeling and varying interpretations among consumers and institutions (Heerdt, 2013, pp. 1–2, 51).

This is important because customers first have to decide what they regard as a green bank when choosing sustainable investment opportunities (Heerdt, 2013, p. 39). To reduce complexity, our analysis will focus on the definition provided by the Green Bank Consortium, where green banks are considered to have the mission driven goals to counter climate change and support the clean energy transition (“What Is a Green Bank?,” n.d.).

Through their efforts in ethical, social or sustainable topics green banks can build more customer trust compared to traditional banks (Heerdt, 2013, p. 1). It is plausible that the ethical part is appealing to customers with regard to security. San-Jose et. al analyzed the Ethical Banks in comparison to traditional Banks (San-Jose et al., 2011, p. 164). Ethical Banks seem to be more transparent and open, while remaining thorough when considering investments and funds. According to San-Jose, ethical banks should include ethical criteria in all their actions and in their internal processes. These banks may produce social-value by actively involving stakeholders in the decision-making process (San-Jose et al., 2011, p. 155). Hence, this could be traced to a different ideology of managers and stakeholders actively interacting to reach a common good (San-Jose et al., 2011, p. 154). This may lead to higher customer trust in the institution, as if an institution fosters transparent practices and constant openness about strategy for shareholders, there will be more information for the latter to act on. This can positively reflect on the business, because more information means more confidence when investing. When the investors are more sure about its future values, they will be able to evaluate projects more accurately, leading to higher market efficiency.

While the green banks in the EU have been actively developed since the 2008 subprime crisis and currently represent the biggest green banks in the world, they are only developing in the US (San-Jose et al., 2011, p. 151; The Banker, n.d.). Nevertheless, it is crucial to evaluate the success of Green Banks in the US when projecting the future of the Green Finance industry as a whole, as North America remains the biggest financial market (Precedence Research, 2023).

Relevance

In 2015 the UN decided upon the 2030 Agenda for Sustainable Development which included the 17 Sustainable Development Goals (SDGs). These SDGs were a blueprint to foster a more peaceful and prosperous world for its inhabitants. Green banks may act on a number of goals, namely those related to taking action on climate change, sustainable cities and clean energy (United Nations, 2015). Similarly, the need for sustainability in finance as a goal in the US future development was only executively decided in the last few years. Mainly through the National Green Bank Act of 2019 that is yet to pass the congress (H.R.3423 - National Green Bank Act of 2019, 2019) and in the Inflation Reduction Act of 2021. Furthermore, has the US set 2050 as the deadline for being a CO2 net-zero country (Inflation Reduction Act Guidebook, 2023) and recently launched $20 billion for green bank programs (Gardner, 2024). Even though there have been notable predecessors, like the Clean air Act, none of them have sought to establish a national Green Bank. In a McKinsey report it is stated that for reaching the goals of 2050 the US needs $27 Trillion dollars. However, the financing of green banks could kick start a system-wide change by financing key technologies, they can potentially mobilize 12 times more than the Greenhouse Gas Reduction Fund (GHGRF) (McKinsey, 2023, p. p.1). Such mobilization could take away the risk and build trust for investing into green projects (McKinsey, 2023, p. 8). This in turn could help disadvantaged communities to “overcome a range of barriers'' and invest into local sustainable projects like solar panels (McKinsey, 2023, p. 31).

However, it is important to mention that with green banks laying a not purely economic focus, some may question whether this would negatively reflect on profits and self-sustainability of the business model. For example, one of the most known examples of an ethical bank is the microcredit Grameen Bank, located in India. Its goal is to give out small credits for disadvantaged groups where a traditional bank normally backs away. The big issue with this bank is that it is heavily dependent on government aid and this aid is counted as profit, thus over-inflating the real profit figures. In reality, the Grameen bank remains heavily dependent on government subsidies to survive while charging interest rates that may reach 20% (Khandker et al., 1995, pp. 63–67), clearly deviating from its original goal of providing affordable credit. As a consequence, it drains money from the government while failing to act upon its original goals. Perhaps, decisions in ethical banks might be made differently if they received less funds from the government and were left to operate as independent institutions.

Banks can account for a huge amount of the sustainable-bond market, by taking different arising opportunities. To name some: they can give out Green, Social or Sustainable bonds to support projects that benefit the environment and/or social goals. As well as transition bonds and Clean energy-project finance loans to support transitions into a carbon emission reduced production. This can have immense consequences on the financing of the much needed transition to a more climate friendly economy (Barnes, 2024). In particular, there is much potential in the financing of the implementation of new green infrastructure like green hydrogen and the support of smaller companies and disadvantaged areas. Therefore, the impact Green banks may have on the US green finance sector and the economy as a whole is immense. It is therefore all the more crucial to provide a comprehensive review of the industry’s financial performance because its ability to generate profit will ultimately determine its future.

Methodology:

Data gathering

Bank selection: First, 38 banks were picked from the American Green Bank consortium list (“American Green Bank Consortium,” n.d.). Afterwards, the reports for banks from the list were accessed in order to collect the key financial metrics (Assets, Liabilities, Equity, Revenue). The main issues arose at this stage, with many banks not providing public financial reports, or only providing a few years.Only 17 banks consistently published data in the database, so others were removed from the study. Finally, banks were classified into 3 categories according to the official classification by assets (< $600 m., >$2000 m, between $600m and $2000 m.) (Reyes et al., 2023)

II. Data analysis

Data cleaning:

First, banks with less than 4 years of published financial data have been excluded from the dataset: incoming assets tend to fluctuate greatly during the first two years, which makes the data points for those banks not reflective of the overall image. Moreover, banks with significant gaps (that could not be filled with accounting formulas) in reports were removed.

This resulted in the total number of banks analyzed being brought down to 15.

Figure 1: Number of banks by size.

Ratio calculation:

Next, bank ratios were calculated: the Efficiency Ratio, the ROE, ROI, Debt and Equity ratio, and Current ratio.

Data visualisation

The data was then imported into python 3.0 as well as R. Correlation analysis along visualization creation was done. As part of the analysis, normalized graphs were introduced which “normalized” the value of a variable over a certain year to 100, allowing a demonstration of relative growth alongside the visualization of absolute growth.

During ratio analysis, however, there were significantly more outliers (due to extremes in data), so an algorithm was written so as to exclude anything 1.5 standard deviations outside the IQR for all years. This enabled a significant simplification for further plotting. Without outlier plotting, many cases would be included where the bank was only beginning its operation, meaning certain ratios (like equity-to-debt ratio) would be very high, which increases the mean for that year. Finally, some variables had to be dropped as they were a product of a ratio, divided by 0, generating an error. Overall, the number of rows that had to be dropped was less than 5, making the impact on the results negligible.

As part of the analysis, Banks were benchmarked (on a set of metrics) against the US national average for banks or the total sector growth, so as to demonstrate an “aggregate” (Federal Deposit Insurance Corporation, 2024). We benchmarked only normalized values, with no ratios being included due to the higher levels of fluctuations among them, making their comparison to normal US banks virtually impossible.

Findings

Afterwards, we visualized the data in R and Python. Overall, the profits of the banks grew: some were able to outperform the market in terms of capital attraction but not in profit.

Profit

As seen from the graphs, profits tended to grow for all banks except small ones. However, the issue with plotting such values is that they tend to fluctuate greatly. The reason for that could hide not in bad management of assets, but rather in the fact that when banks receive public funding, they could be expected or directed to invest more in those projects that are not necessarily profitable for them. For example, in cases of banks that provide more housing loans, they could be expected to give loans to people from an economically vulnerable background, meaning a higher expected mortgage default rate. This serves as a source of growth for the total asset under management and the equity,. However, in the long-run, when the size of the bank may not merely be sustained by the investments of the state, this could lead to an unsustainable growth model for the business.

Figure 2. Distribution of Profit over time by size, (Year/US$ mil.).

Figure 3. Profit trend over time by size, (Year/US$ mil.).

Asset size:

Over time, the average asset size grew for all green banks. However, when put in normalized terms, it is the small banks that outperform the rest. This is mainly due to accelerating investment and many banks older than 4 years created during the period, thus increasing the average asset size largely.

Figure 4. Average Asset Size over time for different sizes by year (Year/ US$ 100 mil.).

Figure 5. Normalized Asset Size over time by size starting from 2013, (Year/ Unit).

Operating Revenue:

Here, the best earners in terms or revenue are intermediate banks, who outperformed both small and large banks.

Figur 6. Average Operating Revenue over time by bank size, (Year/ US$ 100 mil.).

Figure 7. Normalized average Operating Revenue over time by bank size, (Year/ Unit).

Average Equity Size:

Banks have shown relative equity growth, outperforming the US average in terms of growth, but not in terms of size. However, this could again be attributed to a large inflow of investment, especially in recent years due to the 2021 Inflation Reduction Act.

Figure 8. Average Equity Size over time by bank size, (Year/ US$ bil.).

Figure 9. Normalized Average Equity Size over time by bank size, (Year/ Unit).

Asset Turnover Ratio:

The data is as follows, with small banks showing the highest turnover, though this could be due to them having a higher relative investment to their current assets, meaning they are more actively growing their current position.

Figure 10. Average asset turnover ratio size over time by bank size, (Year/Ratio).

Figure 11. Normalized Average Asset turnover by size, (Year/ Ratio).

Current Ratio:

Intermediate banks increase their assets the most, which could explain their highest short-term revenue. However, when choosing 2014 as the base year, we can see that their performance is also quite normal. This is likely due to the fact that many intermediate banks were created in 2013, therefore creating a high asset spike with little to no liabilities. However, it is probable that they took on more liabilities in the subsequent years, effectively normalizing the ratio.

Figure 12. Normalized average Current Ratio Size by bank size, (Year/Ratio).

Figure 13. Normalized Average Current Ratio Size over time by Bank size, (Year/Ratio).

Take aways:

To conclude, Green Banks seem to attract a lot of investment, far above the total market, which lets them ramp up equity regardless of size. The incorporation of sustainable banking practices, especially ones of transparency and openness could mean investors are more eager to invest. This eagerness could be spurred furthermore by the recent IRA, as investors are assured in the long-term support of the green banks market by the government. The US government seems to be highly interested in tackling sustainability with the help of green banks: most banks analyzed received substantial funding from the local governments. Some will benefit from funds distributed through the Greenhouse Gas Reduction Fund. Nevertheless, there also remain concerns about the future of the Green Banks in the United states. This is because there is an argument to be made that in actively funding the green banks, the government makes them too dependent on its funding, meaning it will not be able to sustain the current impressive growth rates over time, threatening a crisis. The data shows high fluctuations, especially when it comes to profits, many banks not having managed to keep a stable ROE or ROI ratio, which is important for a business. Great government dependence may furthermore lead to taking on toxic assets, partially reflected in the fluctuating profits over the years. If the Green Bank is subsidized by the government, it is often expected to give loans to impoverished communities at rates that other banks wouldn’t quote due to high risk. Despite the societal benefits, if the bank accumulates too many such assets, it can unexpectedly sustain losses if the debtors go bankrupt. The greater problem is the lack of larger green banks in the US, as this may lead to them not having sufficient resources to expand and benefit from the economies of scale. Furthermore, a number of green banks are very new as well as their data, which was one of the methodological difficulties, as for many banks, data was not properly reported, putting into question the full imposal of ethical banking practices. Nevertheless, the impact of green banks on the financial sector, sustainable and social goals as well as efforts to preserve the environment seems to grow with every year. For a better view on the development of those banks more time and data is required. We also suggest readers to keep an eye out for reports on the impacts of new sustainability funds and the opportunities that arise with the increasing interest in sustainability. Specifically considering how the higher-for-longer interest-rate regime, led by the US Federal Reserve is influencing lending to sustainable projects since there seems to be highly perceived urgency in sustainable topics (Barnes, 2024).

References

American Green Bank Consortium. (n.d.). Coalition for Green Capital. Retrieved March 28, 2024, from https://coalitionforgreencapital.com/american-green-bank-consortium/

Barnes, S. (2024, January 8). The Future of Sustainable Banking Looks Bright. International Banker. https://internationalbanker.com/banking/the-future-of-sustainable-banking-looks-bright/

Federal Deposit Insurance Corporation. (2024, March 7). Balance Sheet: Total Liabilities and Capital: Total Equity Capital. FRED, Federal Reserve Bank of St. Louis; FRED, Federal Reserve Bank of St. Louis. https://fred.stlouisfed.org/series/QBPBSTLKTEQKTBKEQK

Gardner, T. (2024, July 14). U.S. launches $20 billion in “green bank” programs to curb climate change. Reuters. https://www.reuters.com/sustainability/us-launches-20-bln-green-bank-programs-curb-climate-change-2023-07-14/

Heerdt, H. (2013). Green Banks – The fairy tale of sustainability. Diplomica Verlag. http://ebookcentral.proquest.com/lib/sciences-po/detail.action?docID=1640273

H.R.3423 - National Green Bank Act of 2019 (2019). https://www.congress.gov/bill/116th-congress/house-bill/3423/text

Inflation Reduction Act Guidebook. (2023, September). The White House. https://www.whitehouse.gov/cleanenergy/inflation-reduction-act-guidebook/

McKinsey. (2023). Delivering transformative impact from US green bank financing. McKinsey Sustainability. https://www.mckinsey.com/capabilities/sustainability/our-insights/delivering-impact-from-us-green-bank-financing#/

Precedence Research. (2023, August). Sustainable Finance Market Size, Growth, Report By 2032. https://www.precedenceresearch.com/sustainable-finance-market

Reyes, D., E. Stern, W., & Ramos, N. (2023, November 7). Banking Agencies Finalize Community Reinvestment Act Rules | Insights & Resources | Goodwin. https://www.goodwinlaw.com/en/insights/publications/2023/11/alerts-finance-pif-banking-agencies-finalize-community-reinvestment-act-rules

San-Jose, L., Retolaza, J. L., & Gutierrez-Goiria, J. (2011). Are Ethical Banks Different? A Comparative Analysis Using the Radical Affinity Index. Journal of Business Ethics, 100(1), 151–173. https://doi.org/10.1007/s10551-011-0774-4