As part of the European Union’s broader efforts to combat climate change, reach key environmental objectives across various industries and promote sustainable finance, several initiatives, frameworks and regulations have been introduced in recent years. Key among these are the EU Taxonomy Regulation, a classification system which defines environmentally sustainable activities, and the Corporate Sustainability Reporting Directive (CSRD) and Non-Financial Reporting Directive (NFRD), which mandate greater transparency in reporting ESG criteria. Similarly, in its guidelines on loan origination and monitoring, the European Banking Authority (EBA) mandates the better integration of ESG risks and sustainability considerations into the loan origination and monitoring processes.

The introduction of the Green Asset Ratio (GAR) by the European Commission in early 2024 has been pivotal in ensuring a clear shift to sustainable finance for the banking sector in Europe. Earlier this year, European banks had to disclose their GAR and Taxonomy alignment alongside their Taxonomy eligibility for the first time. The introduction of this new KPI aims to standardise the disclosure of taxonomy-aligned economic activities and their impacts on climate change mitigation.

Decoding the Green Asset Ratio: How is it calculated, and why is it important?

The Green Asset Ratio (GAR) shows the proportion of financial institutions’ on-balance-sheet financing of activities (via loans, debt, and equity investments) that meets sustainable criteria. In other words, it quantifies EU Taxonomy-aligned assets as a percentage of total covered assets.

This metric plays a significant role in ensuring more environmentally friendly business practices and a better integration of climate risks and ESG matters for the banking sector in Europe. By providing a clear benchmark for sustainability, the GAR fosters transparency and encourages financial institutions to integrate greener practices. Understanding exposures within this framework is crucial, as it helps stakeholders understand to which degree financial institutions’ lending and investment activities support the transition to a more sustainable economy.

Tackling the challenges of the GAR methodology

But the introduction of the Green Asset Ratio also created a few challenges for financial institutions. One of them is related to the very definition of sustainability and sustainable activities. What can be considered sustainable real estate? It involves considering energy efficiency, carbon emissions, eco-friendly building materials, location choice, and social impact. While the EU Taxonomy provides a framework that helps define this, accurately monitoring and categorising these activities remains a significant challenge for EU banks.

A complicating factor is the GAR methodology. In fact, some assets are constantly removed from the GAR calculation, which may hinder comparability: sovereigns’ assets, central bank exposures, supranational issuers, and the trading portfolio. Exposure to undertakings and financing to counterparties that don’t fall under the NFRD or CSRD (for example, SMEs and non-EU companies) are excluded from the numerator of the GAR but included in the denominator.

To address these distortions, the banking book taxonomy alignment ratio (BTAR) has been introduced. The BTAR evaluates a bank's alignment with the EU taxonomy in relation to its total business volume. It serves as an additional KPI to correct potential inequalities in the GAR calculation and give a more complete and accurate picture of a bank’s proportion of taxonomy-aligned assets.

To effectively address the challenges posed by the GAR at their own level, banks can enhance data collection and reporting. Investing in advanced analytics solutions can help them accurately capture and report ESG data, ensuring compliance with the EU Taxonomy. Additionally, implementing a standardised template for reporting can improve data consistency and usability across different jurisdictions.

The role of real estate in ESG and sustainability reporting for the banking sector

The real estate sector plays a key role in the GAR, as properties' energy efficiency and environmental sustainability can significantly affect a bank’s balance sheet. As a result, sustainable real estate projects are becoming increasingly crucial, not only in maximising a bank's GAR but also in taking steps towards a greener future.

The introduction of the GAR underscores the urgent need for European banks involved in real estate financing to reassess and adjust loan portfolios to maximise sustainability. Integrating environmental, social, and governance (ESG) criteria into lending processes is thus becoming a crucial strategy.

In this context, PriceHubble offers essential support. Our compliant, enterprise-grade valuation solutions enable financial institutions to swiftly analyse and optimise the level of energy performance of their entire real estate portfolios. With precise and reliable insights including key ESG data, they can achieve their sustainability goals, improve their GAR and comply with EU taxonomy standards.