Financing Fossils: The Banks Behind Coal’s Survival and the Push for Phase-Out

The IMF paper reveals that while global coal financing is shrinking, a concentrated group of banks, particularly in Asia-Pacific, continues supporting coal projects, creating financial risks due to potential stranded assets. Strong coal phase-out commitments and initiatives like the Powering Past Coal Alliance help reduce such financing but face regulatory gaps.

A recent IMF working paper by Gregor Schwerhoff and Mouhamadou Sy, from the IMF’s Research Department, explores why certain banks continue to support the coal industry despite global decarbonization commitments and rising pressure to phase out fossil fuels. The authors analyze data on coal financing and find that a concentrated group of banks, particularly those with high exposure to coal, are now the primary financiers of coal projects. Using a dataset of coal-related bank loans, the study reveals that coal financing has not only diminished in terms of the number of participating banks but has become more concentrated, with select banks bearing much of the risk. Many of these loans have relatively short maturities compared to the operational life of coal assets, presenting challenges for asset owners as they seek to refinance. Countries with strong, legally backed commitments to coal phase-out receive significantly less coal financing, a reduction the authors identify as a causal effect of stringent national policies.

Concentrated Coal Financing in Asia-Pacific

Despite declining global support, coal financing is robust in regions like Asia-Pacific, where demand for coal remains high due to energy needs, particularly in major coal-producing nations such as Australia, Indonesia, and South Africa. Europe, the Middle East, and Sub-Saharan Africa, however, showcase a contrasting trend: the fewer banks engaged in coal financing are significantly more exposed, meaning that financial risks from potential losses are more concentrated within a handful of institutions. The authors underscore that small and low-income country banks with substantial coal investments are at heightened risk, as they often have a high percentage of their equity tied to coal. This risk intensifies given the looming threat of stranded assets as global decarbonization targets become more pressing. The mismatch between loan maturities and the lifecycle of coal plants means that banks with shorter loan terms may extricate themselves before coal assets become stranded, leaving equity holders exposed to potential financial losses as demand declines. This dynamic threatens the financial stability of coal-exposed banks, particularly as the long-term viability of coal assets appears increasingly uncertain.

The Role of the Powering Past Coal Alliance

The research goes further by examining the role of the Powering Past Coal Alliance (PPCA), a coalition of nations, businesses, and organizations committed to phasing out unabated coal. The authors find that PPCA membership and legal coal phase-out commitments have reduced coal financing significantly, especially in countries that legally anchor their phase-out plans. However, an oversight in the PPCA’s scope allows members to limit coal financing only for electricity generation while leaving room for coal support in other sectors. This regulatory gap has implications for the overall effectiveness of coal phase-out policies, as it allows for continued coal usage in industries outside electricity. Another issue highlighted by the researchers is the so-called “green paradox,” where fossil fuel producers, anticipating regulatory restrictions, expedite investments to maximize profits before phase-out deadlines. Such behavior could counteract phase-out efforts, leading to accelerated coal usage in the short term even as long-term policies aim to restrict it.

Financial Vulnerabilities in High-Risk Banks

Schwerhoff and Sy argue that financial stability concerns are warranted, particularly due to the geographical and institutional concentration of coal investments. Asia-Pacific has the largest share of coal financing, but its banks, on average, are better diversified compared to banks in Europe and Sub-Saharan Africa, which show higher per-bank coal exposure. Development banks, for example, are disproportionately involved, with an average of 20% of their equity invested in coal assets, despite global financial institutions like the World Bank ceasing direct coal investments years ago. Banks in lower-income countries are particularly vulnerable to fluctuations in coal markets, as many have less capital to buffer against potential asset devaluations. Additionally, the maturity structure of coal-related loans further complicates the landscape. While coal plants often have an operational lifespan of around 40 years, a significant number of loans extend only up to 10 years. This short-term loan structure could allow banks to avoid prolonged exposure, potentially leaving asset owners responsible for stranded investments if coal plant closures accelerate.

Strategic Pathways for Coal Phase-Out

The authors suggest that joining initiatives like the PPCA could provide a structured path for governments to phase out coal while setting clear expectations for investors. Such frameworks create transparency, allowing banks and financial institutions to adjust their lending strategies accordingly and minimize exposure to stranded assets. Monitoring and assessing the extent of banks’ coal exposure, especially among small or regionally concentrated banks, is essential to ensure systemic financial stability as the world transitions away from fossil fuels. They also emphasize the need for policymakers to remain vigilant about financial risks associated with coal, suggesting that stress tests and simulations could help determine whether banks are resilient enough to handle a large-scale phase-out. Potential regulatory measures could focus on requiring banks with high coal exposure to adopt strategies for reducing their risk and diversifying their portfolios.

Bridging Regulatory Gaps in the Transition

Ultimately, the findings highlight an ongoing tension between the political will to decarbonize and the financial mechanisms that continue to support coal. While the PPCA provides a mechanism for countries to align on coal phase-out, gaps in regulation such as the exemption of non-electricity sectors from coal restrictions might hinder the coalition’s effectiveness. For policymakers, addressing this issue could mean tightening regulatory commitments to cover broader coal usage, ensuring consistency across sectors. By addressing these gaps and closely monitoring high-exposure banks, governments and financial regulators could mitigate the risks of stranded coal assets, facilitating a smoother transition to sustainable energy sources while protecting financial stability.