This piece was originally published in the Sunday Times on May 29th, 2022
Steward Redqueen’s ESG data and analytics manager Claire Nooij explains that while the ESG industry is booming, banks face a major challenge to address ESG issues in their lending portfolios—and many are ill equipped to do so.
What are the main challenges banks face when trying to meet their ESG goals?
“Banks face three big challenges: addressing climate change in their lending portfolios, friction between long-term goal setting in a short-term focused society and maintaining their clientele amidst rising ESG demands. The Bank of England recently made a 10-part pledge to advance the climate agenda. Making the financial system more resilient to climate-related financial risks and to help the industry support a transition to achieving net zero emissions are just a couple of the pledges made. Climate change forces banks to reconsider activities as part of their risk framework by asking different questions than they previously would have, such as what happens to the ability of clients to pay off their loans when they are hit by extreme droughts. Financing the green transition is great, but what about the outstanding loans in industries that are infamous for being large emitters and that society heavily depends on? A bank might not want to give out such loans, but if we are dependent, parties jump in to finance it anyway and the world will not be better off. Another challenge is the friction between committing to a long-term agenda in a short-term focused society. Considering the current pace of becoming net zero, 2050 is around the corner. From a bank’s perspective it is ages away: at least a couple of CEO terms. With most CEO’s not looking further than four to five years ahead, clear ownership to reach the end goal is lacking. At the same time, banks’ clients and investors increasingly demand that they focus more on ESG, so it’s also about making sure banks do not lose business by inadequately addressing ESG. The commitment seems to be there, but how do they go from conversations and goal setting to realisation? This is exactly where banks struggle.”
How much focus should banks be placing on ESG?
“The science from the latest Intergovernmental Panel on Climate Change (IPCC) reports is clear: the costs of addressing climate change are huge. In light of that, banks will need to stop talking and start acting. This means allocating capacity to integrate ESG into policies, processes and performance reviews. Decision-making processes need to be recalibrated for meaningful change throughout the organisation. Banks will also need to have a smart management system that tracks sustainability efforts and engagement with key stakeholders. Finally, it is important that ESG is integrated in the DNA of the bank: from procedures and policies all the way to the interaction they have with clients.”
What should a good ESG strategy look like for a bank?
“First, given the broad array of ESG aspects one could consider and the subjective nature of ESG, it is important that a good ESG strategy has clearly formulated measurable goals that take into account client characteristics, regulations and external commitments, like the Paris Agreement. Second, ESG commitments need to be put into practice by allocating employees, assigning responsibility and including ESG considerations in day-to-day activities, such as loan applications and client onboarding. Finally, banks need to track their progress on integrating ESG efforts so that they can improve their performance over time: after all, what gets measured gets managed.”
In what ways can digital transformation help banks improve their ESG commitments?
“Banks, generally speaking, are dependent on legacy IT systems, which inhibit their ability to manage ESG across their services. Digital transformation and ESG tools enable banks to streamline processes, like loan applications, across the company. Standardised, digital processes for ESG management enable banks to track ESG performance on a client, portfolio and bank-wide level. Information from tracking ESG performance, in turn, can be used for reporting, client engagement and enhancing overall efficiency. Streamlining processes through one central system does not only help banks start small by setting an ESG standard, but it also enables banks to quickly scale up their ESG efforts and realise their ESG commitments.”