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Why adopting Environmental, Social, and Governance (ESG) is a winning strategy for banks

Banks need a comprehensive environmental, social, and governance (ESG) framework to leverage and benefit from the compounding growth of sustainable finance. Whether it’s screening, ESG integration, thematic investing, or engagement, ESG-focused banks have several opportunities available to them to leverage.

With sustainable finance becoming popular around the world, banks are developing strategies to embed ESG factors into their lending and investment decisions. The dilemma with the Banks is how to begin with ESG strategies and ‘Green loans’ can be a good place to start.

Banks can no more just get away by giving lip service to ESG. The need to demonstrate how they have incorporated sustainability into their risk management frameworks and through disclosure of climate, environmental, social, and corporate governance. Banks need to clearly explain how these factors influence their capital allocation, financing, investment, and pricing mechanisms.

What is ‘ESG”

Environmental, social, and governance (ESG) investing refers to a set of standards for a company's behaviour used by socially conscious investors to screen potential investments. ESG associated opportunities and risks are becoming more and more relevant for financial institutions. Not only do ESG considerations make sense for the environment, but sustainable operations are also linked with better economic performance. Banks are therefore concerned not only with their own ESG footprint, but also the ESG risks and opportunities they are subject to as a lender. This is coupled with a constant flow of new regulations which is bringing extensive compliance and horizon scanning challenges for banks.

Leveraging the ESG initiative in the banking industry

Impact investing is attracting enough capital to start having a meaningful influence on the world’s most pressing problems. Globally, more than $22.8 trillion is invested into sustainability. The rapid pace of recent growth has been driven by a key shift in how investors and asset owners view environmental, social, and governance (ESG) factors. As the fastest growing segment of sustainable investing, impact investing is a strategy that financial advisors, and money managers need to get acquainted with, especially as a new generation of investors clamour for it.

Environmental, social, and governance (ESG) issues are top priorities for financial institution executives. A whopping 98% of U.S. banking executives stated they view sustainability as an important part of their business strategy.

The risks

It’s important to recognize there are risks associated with banking in general and ESG is not an exception. There are a group of deterrents who are not happy modifying existing lending strategies. For instance, West Virginia’s treasury informed six large U.S. banks recently they were on a “Restricted Financial Institution List” because they publicly stated they will refuse, terminate or limit doing business with coal, oil or natural gas companies without a reasonable business purpose

Some industry experts, have advised banks and credit unions to be wary of “greenwashing.” That happens when a company overinvests in marketing a sustainable image without following through with sustainable action. Such banks clearly understand the issues but talk the talk and don’t walk the walk.

Yet, there is another side of the coin, especially if financial institutions fail to create a ESG framework/program. Any laggards in the ESG space could be facing increased credit risks and risk profitability if exposure to fossil fuels becomes concentrated on their loan books.

How banks are adopting ESG

With sustainable finance gaining momentum around the world, banks are developing strategies to embed ESG factors into their lending and investment decisions.

  • Negative Screening - Excludes or avoids transactions not aligned with environmental, social, and ethical standards. Currently the most popular technique used for ESG asset management. Negative screening criteria often include issues like weapon manufacturing, tobacco sales, or production of fossil fuels.
  • Positive Screening - Selects corporate borrowers that score highly on ESG factors relative to their peers. Positive screening criteria may include best-in-class screening, companies, and sectors with higher ESG scores compared to their peers.
  • Risk of Investment - incorporate ESG issues in financing decisions to better manage risks and improve returns.
  • Thematic Investing - Prioritizes companies or projects aimed at positive social or environmental change, e.g., climate change, gender equality, prioritizing low carbon initiatives.
  • Active ESG Engagement - to engage with clients on reducing their carbon emissions and to develop innovative solutions to support clients’ efforts to reduce emissions.
  • Sustainable Finance Frameworks - frameworks that outline banks’ ESG lending and investment practices and processes, and often align with well-established international standards.

The opportunity

The growing focus on environmental, social and governance issues is a hazy picture — lacking regulatory guidance or even a consensus of what consumers are looking for. There's a lot to process, but 'green loans' are a good first step for banks and credit unions that want to meet changing expectations. There seems to be risks and reward on all sides — in acting or not acting. The good news is that there are some steps financial institutions can take that can help them stay ahead of the ESG curve. One of them is through sustainable lending, aka “green loans.”

Green loans not only appeal to consumers and investors interested in connecting to a sustainable brand, they also provide a bank or credit union with wholly new revenue streams. Banks that prioritize sustainable lending and create a robust framework and agenda will be best able to leverage the new opportunity.

Giving lip service to sustainability will not work in the future as not only a business opportunity will be lost but more importantly there will be loss of credibility and image. It is important that banks see this as an opportunity. Banks and credit unions can use their support for sustainability to attract and retain both customers and employees - 80% of consumers and 84% of employees are more likely to buy from or work for a company that is seen as actively supporting the environment.

A recent survey concluded 80% of consumers say they are more likely to buy from a company that supports environmental causes. For financial institutions the option to “Go Green,” isn’t easy since measuring environmental impacts can be vague. The difficulty is sustainability efforts cannot be done in isolation, they must embrace the entire organization and must be top-driven.

Let’s engage