The battle against climate change is intensifying, and while individual actions like reducing flights and installing solar panels are commendable, they are not enough. We are in a race against time, and it's clear that large-scale institutional actions are needed to steer the world towards a sustainable future. Enter the banking sector, wielding a surprisingly powerful weapon against climate change: divestment policies.

In collaboration with my colleague Daniel Green, we have unearthed compelling evidence that these policies, enacted by major banking institutions, are not just symbolic gestures—they have a tangible impact on reducing carbon emissions. Coal firms subjected to strict divestment policies slash their borrowing by 25% compared to their peers. This financial squeeze forces these firms to shutter some of their operations, directly cutting CO2 emissions. Until now, the fossil fuel divestment movement, which began in 2006, lacked concrete evidence of its efficacy. Our work demonstrates that when banks pull their funds from coal, the ripples are felt far and wide. The coal industry, heavily reliant on capital from a small set of banks, finds itself cornered with few alternative financing options. This financial stranglehold accelerates the decommissioning of coal-fired power plants, a crucial step towards lowering global emissions.

The implications are profound. If banks apply similar divestment pressures to other high-polluting industries like oil and gas, we could see a significant shift towards a low-carbon economy. Banks, through divestment policies, have a disproportionate influence on what gets financed and what doesn’t. By choosing to divest from fossil fuel, they directly contribute to the retirement of dirty energy sources, making way for cleaner alternatives.

The financial sector has a responsibility—and now, thanks to this research, we know it also has the power—to drive systemic change.

In conclusion, the evidence is solid: targeted divestment by banks works. It reduces carbon emissions and can play a significant role in the fight against climate change. Financial institutions must step up and embrace their role as agents of change. A growing share of investors are explicitly asking their portfolio companies, including banks, to tackle climate change. We need more banks to adopt strong divestment policies and expand them to other fossil fuel industries. The clock is ticking, and the planet cannot wait. It’s time for the banking sector to leverage its immense power and help steer us towards a sustainable, net-zero future. However, it is also crucial to recognize that the magnitudes of the effects we find, while significant, are not large enough for private sector interventions alone to tackle climate change comprehensively. Systemic changes driven by government policies, international agreements, and coordinated global efforts are indispensable. Banks and other financial institutions can indeed be powerful allies, but their actions must be part of a broader, concerted strategy to mitigate climate change effectively.

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By Boris Vallée (Harvard Business School)