For many financial institutions the return of higher interest rates is resulting in greater short-term profitability. But a major report from McKinsey suggests that for all but a select few players with lucrative specialties the gains will not last. What next?
The firm believes institutions of all sizes should regard the next couple of years as a respite, a brief window of opportunity to rethink their business plans. Key to that revamp is finding their place in sustainable finance — green lending and investment activities.
“The banking industry lacks a future-proof business model and the growth premium seen in other industries. This is the time to change the existing model.”
— McKinsey Global Banking Annual Review
In its “Global Banking Annual Review 2022,” McKinsey analysts say they expect sustainable finance to move beyond the sometimes trendy activities denigrated by some as “greenwashing” to a new phase that will push needs for such banking deeper into ordinary people’s everyday lives.
As it is, in some quarters that movement beyond trendiness has already happened. The report provides thought-provoking data indicating how much sustainable finance has grown. Globally, sustainable bonds comprise about 11% of total bond market volume and sustainability-related syndicated loans are about 13% of the global syndicated loans market.
“Only a small percentage of banks have near-term capabilities to finance some of the most dynamic burgeoning areas, including grid-scale infrastructure, green hydrogen, green fuels, biomass, and carbon capture and storage,” the report states.
However, acknowledging that, it goes on to predict that lenders to small businesses and consumers will see opportunities for new business growth as both groups move voluntarily or via government pressure towards green alternatives for facilities, transportation and housing.
Sustainable finance initially represented financing renewable energy, such as solar and wind power in major ways, and totals declined in 2022. However, McKinsey expects volume to return in those sectors, in part due to government influence such as the Inflation Reduction Act in the U.S. The firm estimates that the act’s extension of existing tax credits and creation of new ones could almost double availability of solar and wind power in the U.S. by 2030.
In addition, the need for additional forms of sustainable lending will expand. The firm estimates that the amount of financing needed for residential adoption of solar energy worldwide rose to $40 billion in 2021, an increase of 185% over 2017’s $14 billion.
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Why Banks and Credit Unions Must Strategize Now
During an advance press briefing on the massive report, Miklos Dietz, senior partner, said that “small or big, you have a few years to shape your future in ways you couldn’t have in the last few years.”
He said there will be a temptation to just fine tune things while the sun shines, but that the harder work of reinvention is essential and urgent. In this regard, Dietz said that smaller institutions actually enjoy greater potential agility to make such changes than do major institutions that take longer to shift.
Dee Yang, partner, addressed aspects of the firm’s recommendation to dig deeper into green finance. She noted that Puerto Rico, still recovering from Hurricane Maria, was hit by Hurricane Fiona in fall 2022. Financial institutions have played a role in providing access to solar panels and batteries that were needed to rebuild, she said. This is an indication of how quickly smaller banks and credit unions could make the shift to more green financing activity.
“Our message is not that sustainable finance plays only serve larger banks,” said Yang, “especially if you understand that the shift towards a low-carbon economy affects businesses of all sizes and households everywhere.”
The report, speaking globally, sees green in “green.”
“Financing the energy transition will require a massive reallocation of capital,” the report states. “Banks are on the front line to provide financing and advisory support for a wide range of opportunities.”
Potential Opportunities for Retail Banking Institutions
One of the most apparent opportunities on the consumer banking side is financing electric vehicles. As of the second quarter of 2022, electric vehicles constitute only 5.7% of new vehicle registrations in the U.S., but this has been steadily growing over the last decade, according to figures from Experian.
In addition, the company indicates that figure is split evenly between Tesla and other EV manufacturers. Tesla formerly dominated the mix but other companies’ offerings and sales have increased. Banks accounted for just over half of electric vehicle financing in 2021 and credit unions accounted for about 12%, according to an earlier report on electric vehicle financing on The Financial Brand.
Availability of charging stations is far from uniform, and that may create financing opportunities both among commercial establishments that want to add fast-charging capabilities for customers as well as homeowners who want fast-charging at home.
Regarding home charging: While it is possible to charge an electric vehicle from a standard outlet with a simple plug-in Level 1 charger, it takes many hours, according to MotorBiscuit.com. The site says that a much quicker dedicated Level 2 charging station can run an estimated $1,700 to $7,000 to install, depending on the configuration, the cost of local permits and more.
Another opportunity McKinsey identified are “green mortgages,” loans to finance the purchase of energy-efficient homes or to pay for energy efficient home improvements. Often these carry a lower rate as an incentive to encourage energy-efficient housing. Frequently this relies on a state or local subsidy of the discount. Adoption of these mortgages has been somewhat limited, according to the U.S. Department of Energy’s website.
Both banks and specialized lenders have already been financing solar energy installations for homes.
There’s a potential “green embedded finance” opportunity here, McKinsey suggests, as part of electric vehicle digital platforms that provide consumers with one-stop electric vehicle education, purchasing and financing options.
On the other side of the balance sheet, the report points to demand for “green deposits.” Both traditional depository institutions as well as some neobanks, such as Aspiration and ATMOS, have offered such programs. The general idea is that deposits are not funding such activities as fossil fuel exploration and production. MightyDeposits.com tracks “eco-friendly” banks and other financial firms that offer such saving and investment opportunities.
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Potential Opportunities for Small Business Banking
It’s still early days on this front, but the McKinsey report suggests that sustainability among midsize and small businesses will create openings for financial services players.
“Growth for banks serving these markets will be rooted in scalable financing solutions for commercially viable products and services, as well as in providing expertise and capabilities,” according to the report.
Among the potential opportunities will be lending for companies that are retrofitting their facilities for energy efficiency. This includes financing energy-efficient equipment as well.
Businesses that rely on transportation to deliver their services or products represent another financing possibility, through bank-provided fleet finance.