Leveraging Internal Carbon Pricing (ICP) for Financial Institutions: A Framework for Aligning Profitability with decarbonization objectives.

This study reveals the potential of internal carbon pricing (ICP) as an essential tool for financial institutions to align their profitability goals with carbon reduction targets. The research aims to establish a practical framework for applying ICP in daily financial operations, such as loan approval processes and investment decision-making. By integrating ICP into these activities, institutions can effectively balance environmental sustainability with financial performance while advancing towards carbon reduction targets.

The implementation of ICP involves four key processes:

• Establishing  internal carbon pricing : Utilizing scenario-based methodologies to calculate ICP by assessing external carbon costs and internal financial risks, providing a basis for carbon-related evaluations.
• Incorporating ICP into Carbon Management Indicators: Embedding metrics such as absolute emissions, emission intensity, and reduction pathways into operational systems to assess and manage the carbon impact of financial portfolios.
• Integrating ICP with Financial Metrics: Linking ICP with traditional indicators, such as risk-adjusted return on capital (RORAC), to assess the combined impact of carbon risks and financial returns, creating a comprehensive decision-making framework.
• Evaluating Transformation Plans: Quantifying the carbon reduction potential and financial implications of long-term business transformation strategies, factoring in projected carbon costs and benefits.

The study demonstrates that ICP can serve as a practical mechanism for financial institutions to incorporate sustainability considerations into core business operations without compromising profitability. By linking carbon pricing to both operational and financial metrics, institutions can enhance their decision-making processes and gain a competitive edge in the transition to a low-carbon economy.