Other parts of this series:
Public pledges by HSBC, ING and UBS to curb their funding of fossil fuel production are welcome signs that the shift to sustainable banking is gathering speed. These banks, among others, are using their allocation of credit to encourage sustainable business practices. They recognize that sustainable lending is critical for the well-being of their own businesses as well as the long-term success of their customers. Unless companies embrace sustainable business practices, they’re unlikely to survive.
Sustainable lending is key to sustainable banking. It brings environmental, social and governance (ESG) concerns into the heart of a bank’s decision making. Clearly, it requires banks to up their financing of organizations engaged in sustainable business practices. But it also obliges banks to help companies with poor ESG records transition to more sustainable practices to avoid their funding being curtailed. Few institutions have made significant progress in both aspects of sustainable lending.
Loans linked to sustainability increased in value by more than 50% last year
Rewards for banks that excel at sustainable lending will be substantial. Loans linked to sustainability increased in value by more than 50 percent last year to around US$200 billion. Yet they’re still only a small fraction of the whole credit market. By contrast, investments in instruments tied to sustainability currently account for more than a third of the over $50 trillion in assets under management in the US—a leap of 42 percent in the past year. There’s no doubt that the market for sustainable loans is going to soar.
Barriers to ESG lending
So why have banks been slow to adopt sustainable lending?
Regulatory uncertainty, concerns about unproven business models, doubts about how to price risk in sustainable ventures: they’ve all impeded the growth of sustainable lending. But the biggest barrier is that some banks have yet to properly structure their businesses to accommodate sustainable lending. Often, they’ve invested heavily in the end-to-end processing of loans and are wary of losing recent gains in efficiency.
How to succeed as a sustainable lender
We’ve identified four steps that will enable banks to restructure their end-to-end lending processes and capitalize on the demand for sustainable lending.
- Transform lending value chains: Adjust credit products, policies and processes. Create an industry-specific ESG front office and ensure that all lending operations are sustainable. Patchwork solutions and labor-intensive tasks such as manually integrating ESG data into credit assessments are unlikely to succeed.
- Reskill the lending practice. Prioritize the training of staff in ESG lending using modular instruction courses, certification programs and a forum where participants can share educational experiences and best practices.
- Build an ESG data platform. Establish a central data utility, an ESG score methodology for listed companies and a formal process for obtaining sustainability information about non-listed businesses. Ensure that the data platform can evolve, scale and strengthen security so that it continuously improves the organization’s decision-making capabilities.
- Expand the risk management framework. Establish a governance process to identify ESG risks that need to be included in the organization’s risk management framework. Integrate ESG risks with financial risk management policies, processes and systems. Ensure that the risk management framework is sufficiently flexible to accommodate changes in risk assessments prompted by on-going improvements in the quality, volume and sources of ESG data.
If you’d like to discuss this post or other aspects of sustainable banking, contact me. I’m keen to hear from you.
In my next blog post, I’ll discuss how far-sighted banks can transform their organizations to meet their net-zero commitments. In the meantime, have a look at our recent report, Sustainable lending: An action plan for banks, to learn how to capitalize on the opportunities in sustainable banking.
