Banks are the lifeblood of any economy, having the ability to steer it by redirecting capital where it counts, but also retaining it from other sectors. It is therefore imperative that banks participate in the transition towards more sustainable development.
As in other sectors, we have seen several banks’ views on environmental, social and governance (ESG) dimensions evolve – from being seen simply as philanthropic or corporate social responsibility activities to now becoming the heart of operations and business model.
Financial institutions are encouraged to integrate ESG into their overall strategies and risk management frameworks, as well as to increase their non-financial disclosures.
These demands, which were originally pushed by regulators, are now increasingly market driven, with customers and investors demanding more information about what is being funded and the societal impact it could have. .
This translates into growing expectations of financial institutions to make public commitments and take action on the ESG front. Inevitably, this puts pressure on boards to step up their game and actively engage and lead their banks through a number of actions to take.
Boards are encouraged to define their bank’s ESG ambitions, positioning their bank anywhere from being a catalyst in the market to meeting minimum regulatory requirements.
By articulating their position and communicating it from top to bottom in their institutions, boards of directors will give impetus to their staff to implement the necessary changes, in the various functions, of trade credit, mortgages, retail banking, from compliance and risk management, to operations. , asset management and human resources.
Banks are increasingly being asked to assess the ESG risk exposure of their portfolios, with a focus on both physical and transitional climate risks.
For example, banks are asked to understand their exposures to climatic events (eg the impact of floods on the value of secured assets), while analyzing the risks resulting from the evolution of economies towards decarbonization.
Boards need to know which sectors and/or projects present the highest ESG risks and then decide which sectors can potentially exit and which to support in their transition journey and at what pace. For example, switching from fossil fuels will be gradual and will require time and investment from customers.
Despite the challenges that increased regulation brings, there are also opportunities that can be exploited. Indeed, boards of directors are in the best position to balance ESG-related risks with the growing opportunities that the environment brings.
Banks are increasingly asked to assess the exposure to ESG risks of their portfolios– Maria Giulia Pace and Clarissa Micallef
For example, new green products are in demand (e.g. green loans), new industries (e.g. renewable energy) will need financing, and ESG-compliant investments will be sought to channel excess cash into value-added projects.
In a recent EY report, “How Bank Boards are Elevating Sustainable Finance and ESG,” the sentiments of US bank managers towards ESG were highlighted. Among other things, the report presents the results of a real-time poll at a recent roundtable for bank managers, organized by EY Financial Services Center for Board Matters.
Sixty-three percent of respondents see ESG as a mix of risks and opportunities, while only six percent see it more as a risk. On the other hand, preliminary discussions within the industry indicate that locally ESG is still seen as an additional cost and risk.
Discussions with a number of local banks indicated that one of the main challenges for boards is to keep abreast of the regulatory volume, identify the myriad of regulations and guidelines issued and filter those which are applicable.
These regulations are mainly principle-based, which on the one hand is understandable and practical, but also leads to a lack of clarity on how to apply them.
Another common challenge is the lack of ESG data found at different levels. Most clients still have limited or no ESG data, while at the national level, climate studies and vulnerability assessments are still ongoing.
Consequently, risk models remain difficult to feed with reliable input data. Additionally, risk management methodologies are still being developed and standardized approaches being determined.
However, as one American bank manager put it, “missed opportunities become risks”. It is therefore necessary for the authorities to lay the foundations for a local ESG framework as well as any necessary studies, such as climate studies, so that the banks can then seize these opportunities and ensure that their ESG efforts are in line with in a larger framework. national dynamism.
Many banks don’t want to jump in and push the market too early before national regulation is in place.
While 69% of US roundtable participants felt somewhat prepared to measure the impact of climate change on their business and operations, local banks appear to be at different stages of their ESG journey.
Yet all recognize the importance of these topics and recognize that integrating ESG into their strategy is the way forward.
Boards must therefore juggle between achieving current results and taking a longer-term view of the ESG journey.
Channeling funds to ensure the economy becomes greener, more inclusive and well-governed, while minimizing their own risks – perhaps the closest win-win situation one could ask for.
Maria Giulia Pace and Clarissa Micallef are Economists in EY Malta’s Climate Change and Sustainability sub-service line.
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