BANKING ON SUSTAINABILITY
How banks can engender sustainable business – Kiran Dhanapala
The Corporate Knights’ annual Global 100 of the most sustainable corporations lists entities with greater investment returns, better governance in ‘CEO to worker pay ratios,’ greener performance with double the carbon productivity, higher revenue from clean goods and services, more women on their boards, and links between sustainability measures and executive pay.
Two banks are in the top 10 – namely Banco do Brasil and Shinhan Financial Group, ranked eighth and ninth respectively. So what makes banks rank high in sustainability?
There’s the fundamental legal and ethical obligation of financial institutions (FIs) to act diligently, and protect the interests of investors and depositors – a.k.a. fiduciary responsibility.
In the aftermath of the global financial crisis, banks have been keen to win trust and are alert to risks that weren’t considered previously. These include business risks impacting the environment and/or society, and natural resource risks that may impact business – e.g. water scarcity.
While FIs aren’t responsible for enforcing environmental and social laws, they need to protect clients against risks that can be reasonably identified and mitigated. So an FI officer must be trained to understand and assess potential risks. Moreover, FIs can invest and lend more effectively by promoting sustainable practices, making for improved banking business overall.
Banks also face reputational risks amid tighter scrutiny by civil society. For example, a 2018 report by Friends of the Earth Netherlands and theCentre for Research on Multinational Corporations found links between Dutch banks and industrial palm oil companies.
Banks offer individual customers shares in investment funds; but they don’t screen or provide information on all companies in investment funds offered to customers. A legal gap in the environmental, social and corporate governance (ESG) impacts of investment funds was found in the Netherlands.
Overall, the report notes that voluntary measures were ineffective in addressing social and environmental safeguards in the financial sphere, thereby calling for legislation for all investment funds to report ESG risks and impacts in line with standardised criteria. This illustrates that voluntary steps may in time turn into mandatory measures enforced by regulators.
As for the common issue of banks aiming to be carbon neutral, that involves more than clean energy and energy efficiency. Globally, banks are divesting out of coal or modifying lending policies to restrict their exposure to coal. The World Bank was the first to announce that it would stop funding for coal projects in 2013.
The Institute for Energy Economics & Financial Analysis (IEEFA) notes that bank divesting policy announcements have occurred every two weeks since last year. Many have made public commitments to invest in clean energy. But IEEFA highlights inconsistencies between funding clean energy and endorsing climate change agreements while remaining top investors in coal globally.
This proves the importance of banks transparently and fully reporting climate friendly investments, and activities that are financed but contribute to greenhouse gas emissions – i.e. ‘green’ and ‘brown’ investments, and policies on the brown sector.
For example, the World Bank has announced its halting of support for oil and gas exploration from this year. This means tracking brown finance activities and green metrics, and proactively reporting exposure based metrics – counts, percentages and currency values – contributing to climate problems and solutions.
Incentives exist to shift bank funding from coal to renewables and other sustainable practices. Last year, the Hewlett Foundation offered US$ 1 million in grants for retail banking projects and banks to adhere to environmental principles in investing.
Global evidence points to sustainability being good for business – and banks can assist in incentivising good practices among clients. A new approach – sustainable lending – links loans to lower interest rates when a client meets prearranged sustainability targets. This differs from green loans and bonds. It is for daily corporate use and the interest rates aren’t fixed but rather, linked to corporate performance and ESG criteria.
European banks are offering sustainable credit facilities with sustainability rating agencies providing assessment services. Lowering the cost of capital depends on independent verification of ESG target achievement. Such loans demonstrate the innovation and commitment of banks and clients to sustainability.
For clients of banks, positive ESG performance demonstrates good management and lower credit risk. It also indicates that companies are committed to being held accountable for ESG performance.
Creating a bank strategy and mission linked to sustainability, and embedding this in every aspect of bank operations, is vital.