This past week, the Financial Times and IFC (World Bank Group) announced the winners of the 2010 Sustainable Banking Awards (http://bit.ly/ZNISO). The annual awards recognize banks and other financial institutions that have shown leadership and innovation in integrating social, environmental and corporate governance considerations into their operations. Short of two funds, American banks were absent from the list. Let’s face it, with the global economic collapse of the past two years, and the banking industry’s corporate social responsibility reputation in the tank, Wall Street firms and the banking industry in general is under pressure to “do good” (http://bit.ly/a5D7r4). But all is not lost and it’s not too late for banks to regain consumer confidence while improving their operations and bottom line.
Unfortunately, the current economic downturn and lending issues faced by the banking sector has created a threat to “triple-bottom-line” focused sustainability i.e. green programs that are meant to manage banking risk being neglected or moved to the bottom of the “to do” list. I am not talking about the ‘low hanging fruit’ like lighting retrofits or e-statements or recycling programs (all good starts by the way). My focus is on seeing banks implement deeper initiatives focused on governance, sustainability focused risk, reputational management, and value-added community benefit.
The Environmental Minefield that Banks Walk Through
The banking sector generally perceives itself as environmentally neutral. However, the regulatory landscape that large commercial and community banks often find themselves walking through is constantly changing and looks more like a minefield. Although banks themselves do not largely impact the environment much through their own ‘internal’ operations like a large scale manufacturer or developer might, the ‘external’ impact on the environment can be substantial. That is because banks like any other business may be potentially liable for environmental damage that their operations or fiduciary involvement may cause. In banks cases, the concern is on derived environmental liability through debt and equity transactions.
The “Green” Question
Environmental and corporate social responsibility issues highlight both risks as well as opportunities to banks. The banks and financial institutions that made the FT 2010 list are serious about greening their operations and financing sustainably-focused projects that put sustainable governance at the heart of decision-making. Not only does this leverage a bank’s risk, but it’s value-added in the long run. How? Because substantial evidence is available that demonstrates how environmentally responsible investments and projects that ’give back’ to a local economy more than they “take’ are better investments in the long term.
There are no specific legislative drivers to encourage better performance in terms of sustainable lending or project finance. However, several voluntary standards and sets of principles exist and are gaining steam in the business marketplace. Examples include the Equator Principles (http://www.equator-principles.com) , World Bank IFC Guidelines, Global Reporting Initiative (GRI) Finance Sector Guidelines (http://bit.ly/aFmaYe), and even Securities and Exchange Commission federal reporting requirements. Leading international finance and local banking institutions have signed on to many of these guidelines, which are rapidly becoming the “norm” in the banking industry. Only a few U.S. financial institutions have stepped up to the plate so far, notably Citigroup, Wells Fargo, Bank of America and JP Morgan Chase.
The Risk Management Challenge
Environmental issues present the banking sector with a daunting and often long term challenges. Banks can face financial risks from borrowers defaulting on the repayment of their loans because of fines imposed for poor environmental performance. As I already noted, current environmental regulations in the U.S. can make banks liable for environmental damage caused by borrowers. Banks, therefore, need to strive to minimize these risks with the introduction of measurable and verifiable environmental criteria into their credit policies and overall lending processes. All too often, evaluations are often made on unverified business pro-formas, deficient appraisals, or on applicants environmental reports, often compiled on a voluntary basis.
However, the lack of environmental and other sustainability criteria in a loan-vetting process may prevent banks from estimating the full risk premium of investments and expose the bank to further short and long term risk. Therefore, banks might consider starting by reassessing their credit policies and loan screening processes to assure that sustainability is accounted for.
Solutions that Add Value and Real Sustainability
A growing body of quantitative and qualitative data demonstrates the bottom-line benefits of sustainability-focused credit risk management performance in the banking industry are evident in the market place. Some key benefits of such an approach, reported by over 85% of banks surveyed that have implemented similar programs) include:
- Improved Financial Performance
- Reduced Operating Costs
- Enhanced Brand Image and Reputation
- Increased Loan Originations and Customer Loyalty
- Increased Ability to Attract and Retain Employees.
To be and to stay on the leading edge of our new financial world, forward- thinking banks must consider developing robust, performance based lending policies and processes to ensure that 1) the organization not only offers competitive products to its customers and gives value back to the community in which loan assets are located, but 2) the organization protects its fiduciary position, environmental and reputational risk from servicing questionable projects. So far here in the U.S., efforts by established banking institutions in the “deep-sustainability” space is scant, and I can only point to a few real, demonstrable leaders with a firm track record in this area.
My company’s approach to ‘green’ banking focuses not only on helping our clients find the obvious ‘low hanging fruit’ as I noted earlier, but get to the “core” risk management success factors that can make or break a bank:
- Sustainability focused operations procedures & policies;
- Value-added bank loan/credit risk management tools and sustainability scoring indices, leading to innovative customer products and enhanced profit streams.
- Working with compliance and regulatory agencies interacting with financial institutions.
How well banks handle social and environmental risks is increasingly important because, in today’s global economy with unrestricted information flows, such risks can affect a bank’s reputation and long-term business success. Who knows- with a little guidance, innovation, determination and daring, more U.S. financial institutions may make the FT Sustainability Banking 2011 list. I’ll be watching where my money goes- will you?