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Monday, 17 June 2019

Guest Comment: The rise of sustainable banking

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Low interest rates, increased globalisation and the impact of stricter regulation have all contributed to producing a global banking industry that is perhaps more competitive than ever before.

Understandably, such a competitive landscape will force some market participants to focus on short-term survival and profitability rather than long-term sustainable practices.

Of course, banking practices will remain driven primarily by commercial considerations around risk and opportunity calculations, yet with the increased risk and proximity of natural resource shortages threatening economic growth and business profitability, sustainability now has a growing weight in reaching these assessments.

As such, a shift is taking place in the banking industry. While banks have been supporting sustainable initiatives for more than 20 years – by financing sustainable energy projects, for example – banking involvement in sustainable trade is now going further. Today, there is far sharper focus on how goods and services are produced and delivered, and banks are placing significant pressure on themselves to ensure that they check trade-related transactions for environmental, social, ethical and governance considerations.

Key drivers of sustainability in the banking industry

Certainly, the sustainable banking trend is gathering strength and there are four key factors that can help explain what is driving this. These include: risk management, building a positive reputation, anticipating regulatory change and taking advantage of new business opportunities.

Risk management is perhaps the most important factor. The perceived risks are mainly indirect; for example, damage to infrastructure from an extreme weather event caused by climate change. But some risks can also be direct, such as credit risks to clients’ commercial prospects derived from sustainability-related events or issues. Therefore, environmental, social and ethical risks relating to the products or industry sector being financed, or location of the financing activity are increasingly being taken into consideration.

Reputational risk is another factor. Confidence in the banking industry has been shaken since the financial crisis. As such, enhancing the industry’s credibility on sustainability issues is important and failure to take the right precautions can lead to banks’ association with polluting, exploitative or ‘unethical’ customers.

Third, is the need to address or pre-empt new regulatory expectations in order to gain a competitive advantage. Many financial institutions in OECD countries now adhere voluntarily to sustainability schemes, such as the UN Principles for Responsible Investment. However, the trend is not limited to OECD financial institutions; it is becoming increasingly noticeable in BRICS countries, such as Brazil, for example, where the move towards mainstreaming sustainability issues has already moved from ‘guidance’ to being manifested in policy and regulatory frameworks. As such, banks around the world need to be ahead of the curve in preparing for future regulation change.

Finally, banks are becoming more proactive in sustainable trade because of new opportunities to develop products and services that create or respond to new needs among corporate borrowers. For example, banks are playing a part in establishing new markets for offsetting carbon.

While sustainable trade may still be in its infancy, it is an area which is growing and sustainability considerations have now become part of day-to-day practice in many leading banks – almost as important as assessing the creditworthiness of a borrower.

Going further in sustainable trade

In this respect, the role of banks in encouraging sustainable trade has gone beyond the traditional act of financing sustainable projects and technologies to applying a sustainable lending criteria which increasingly incorporates consideration of non-financial factors into decision-making.

At Commerzbank, for example, we have had a sustainable lending criteria in place for many years and our Environmental, Social and Governance (ESG) Risk Management department cooperates closely with other business units to check every trade-related transaction we receive for environmental, social and ethical risks. Last year alone our business departments conducted in-depth and extensive checks on 5000 transactions. In extreme cases where our sustainability criteria are not met, our checks may lead to the rejection of a transaction or termination of a business relationship.

For example, in the case of proposed finance deals in connection with timber contracts, the ESG Risk Management team undertakes a range of investigations, including whether there have been reports of illegal logging by companies or whether the timber in that area leads to a risk of deforestation. We also always ask for the Latin name of the wood in order to carry out as thorough a check as possible. If corporate clients fail to meet these criteria, we reject the transaction outright.

Banks, as the entities that finance corporate activity, probably have more impact on the uptake of sustainable business practices and strategies than many other sectors. Yet, for the sustainability drive to really accelerate, some banks will have to accept that there are some deals that cannot be touched. In this respect, we are at the end of the beginning in terms of really achieving sustainable trade.

Therefore, more collaboration will be necessary, both among banks, as well as corporations, governments, policy makers, non-governmental organizations and the academic world, in order to establish and fulfil basic sustainability standards.

 

Ruediger Geis is Head of Product Management, Trade Services and Issues at Commerzbank. He was heavily involved in the production of the recently-released report entitled Five drivers of Sustainable Trade. 

For more commentary from IFR, click here

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