The ESG challenge in banking is real — and massive

Transitioning to a more environmentally and socially sustainable world has become an urgent business imperative for banks and other financial services institutions. The financial services sector has a huge role to play in making this transition through the mobilisation of capital.

However, sustainability is not only about ethical principles. It also has everything to do with the oldest of banking principles: risk. Climate change and social factors can bring tremendous risk to a bank’s assets and reputation. The environmental, social and governance (ESG) agenda is driven not only by a change in corporate values, but also by customers, regulators, colleagues and investors. This massive, multidimensional challenge can be daunting, but it can also be an opportunity.

Some banks are already well down the ESG path. They have chosen to stop or radically reduce funding of certain sectors. They are actively promoting sustainable financial products. They have baselined their greenhouse gas (GHG) emissions. But most financial institutions are just embarking on the journey, and the sheer scale and depth of the change is top of mind as they wonder: Where should we begin? What should we prioritise?

Our answer? Put in place three essential foundations: an ESG data platform; green IT; an integrated delivery plan. You don’t want to be left behind on this one, in the way that some firms found themselves left behind on digital transformation, the last change of comparable scale in the banking industry.

ESG is not just CSR on steroids

Let’s first take a quick look at ESG’s impact across banking. ESG is not just corporate social responsibility (CSR) on steroids, nor is it a compliance task. It is a massive transformation that requires a fresh mindset and widespread change across the entire organisation. Critically, the ESG effort extends downstream in the activities that are financed by the bank and upstream in products and services acquired through the supply chain. Indeed, for most financial services institutions, by far the largest carbon footprint and social and governance impact will be external.

When developing your ESG strategy, you will need to think through what ESG entails across multiple dimensions:

• Impact. Track the ESG impact of loans, investments and other products. Establish new policies for investment that factor in ESG concerns.
• Revenue. Create new products and services that drive brand loyalty, new revenue streams and sustainable outcomes.
• Risk. Assess how climate and social factors may impact all the traditional pillars of financial risk, i.e., credit risk, market risk, liquidity risk. Understand the reputational risk that can come with allegations of greenwashing.
• Reporting. Provide reporting and disclosure for stakeholders, including risk modelling.
• Culture. Embed an ESG mindset in business processes and governance so that this is not an afterthought.

Unlike most transformations that affect just a few parts of the business, ESG plays out across every part of the enterprise, though differently in each area. For example, ESG revenue in capital markets may come from green bonds and social impact bonds; in wealth management from products that allow customers to align investments with their ESG values; and in retail from lower interest rate mortgages for energy-efficient homes, carbon-impact calculators or carbon offset services. When it comes to ESG impact, building societies may want to consider the potential impact on the social mix of a neighborhood if they make loans to gentrify properties, while in corporate banking, loans may need to be linked to the achievement of social or environmental outcomes.

About the authors