Banks play a key role in society by providing the capital required for resources to be used and social engagements to flow. Yet with the world’s resources quickly being depleted, banks risk incentivising environmental and socially destructive practices for their own profit or out of ignorance. According to research by KPMG and the WWF, many banks are starting to pull money out of unsustainable business models and pump money into sustainable ones, using internal environmental and social strategies to push through such changes. However, many still face internal challenges, from poor KPIs to not pushing the strategies to implementation level.
Banking has been around for centuries, and in that time has helped facilitate a considerable benefit to the societies in which they are permitted to operate. Among others, they provide capital and credit to people and organisations which in turn allows them to create jobs, wealth and goods. The existence of banks in society does however come with conditions. Through their business activity, banks directly and indirectly finance activities that draw on the Earth’s finite natural resources and thereby finance activities that may have negative effects on the environment’s biodiversity and its people. Furthermore, the activity of banks bears on the wider financial system and can cause potentially disastrous outcomes for society at large by ignoring or not correctly judging risk related activity.
In a recently released report, KPMG and the World Wildlife Fund consider the role banks play in dealing with environmental and social ‘megatrends’, including the world’s growing global population, the increasing scarcity of water and other resources and changing weather patterns. The report, titled ‘Ready or Not? An assessment of sustainability integration in the European banking sector’, explores the level of integration of environmental and social (E&S) considerations in core processes of the bank with particular attention to translating policy into practice (‘beyond policy’).
These megatrends are expected to come with their own systematic and sometimes latent risks for a wide range of businesses that are involved in practices that are dependent on resource abundance or predictable climate and weather conditions. One of the flaws of the current economic model, according to the authors, is that it fails to adequately account for environmental and social risks in valuing and rewarding economic activity.
Money managers are waking up to the potential dangers of failing to grasp at least the environmental side of such risks. A recent Mercer report finds that investment managers need to carefully consider the climate change risks associated with the industries and practices into which client money is invested. Banks are also increasingly confronted with these megatrends and their impact on the financial performance of their customers, and risk profiles of their loan and investment portfolios. Their role in allocating capital to unsustainable sectors therefore plays a role in the eventuation of possible long-term risk outcomes as well as their social consequences. Banks have the ability to price material E&S externalities and by doing so help catalyse the transition toward a more sustainable global economy.
According to the research, 17% banks of banks take E&S risk mainly as reputational risks. This means that they are seeking to avoid doing business with companies implicated in environmental pollution or human rights violation. 83% have however, gone a step further and now also have E&S strategies in place that seek to create value for the bank and society. Such strategies aim to provide financing for the transition to a low-carbon economy or more sustainable commodities supply chains.
Of the surveyed banks, most have taken E&S considerations to the next level, aligning business strategy with sustainability strategies. 42% of respondents have strongly aligned their business strategy and environmental strategy, making E&S an explicit part of their strategy. However, only 1 bank has set quantitative KPIs for its strategy, with the risk that merely a qualitative framework for evaluating E&S strategies leaves too little bite to the strategy such that it is easily labelled marketing or reputation enhancement action.
Accountability for E&S performance remains an issue for many banks, and while sustainability strategies are now more advanced they lack being fully embedded within many banking institutions. Ownership and accountability of sustainability performance and implementation is still only assigned to sustainability departments and Board member(s)/committees in 50% of the banks, even though board involvement is shown to be relatively critical in the success of sustainability programmes.
Sustainability related KPIs are in many institutions fully integrated into the wider governance framework of banks. One bank had no KPIs, while 42% only had KPIs at the sustainability department-level and/or board-level, meaning that a potential mismatch might arise that can further prevent the integration of E&S factors in the business processes and activities of the CIB divisions. Accountability and ownership, including integration of E&S factors in incentive schemes, are important elements for creating a strong E&S risk culture within the division to stimulate the desired conduct of employees.
Besides internal considerations related to the implementation of strategies within banks to safeguard E&S risks within banks, there are also requirements for banks to release their risk exposures, measures, and management to external stakeholders. Given the material risks faced by banks from E&S considerations, some scope for the discloser of E&S risk policies needs to be accounted for by banks.
In 17% of banks surveyed however, no disclosure is made. A further 33% just disclose a summary and 25% provide a complete E&S risk summary. Reporting and disclosure on risk exposures of banks related to E&S factors is not yet common practice at these banks, with 75% only providing a disclosure breakdown for the project finance portfolio.