Turning the banking world green

In a recent letter, Larry Fink, the chairman and CEO of BlackRock, the world’s largest asset manager, said, “climate risk is investment risk.” He went on to say that the world is “on the edge of a fundamental reshaping of finance.” Clearly, Fink believes that companies that are “green” will get their funding and grow, whereas those who can’t demonstrate that they are either there already or moving towards it risk being pushed out.

Without knowing the thoughts behind Fink’s letter, it is evident that one of the consequences of the election of President Joe Biden is to plant the subject of ecological responsibility firmly back into the laps of businesses and their bankers. During the four years under Trump, the whole subject of climate change and greenhouse gas emission was downplayed, culminating in the withdrawal of the USA from the Paris Accord. It allowed the imminent consequences of the push for greenhouse gas control to slip away from most discussions. But with the rejoining of the US into the Paris Accord, the subject has come roaring back. It will play a significant part in relationships of central banks in setting monetary policy and of commercial banks who must now inject a level of sensitivity to the whole question of the possible or likely risk of their customers being adversely affected by this development.

A growing trend is the use of Environmental, Social, and Governance (ESG) criteria in setting policies for bank lending and investor evaluations. ESG is a set of standard targets against which socially conscious investors grade a company’s operations as they screen for suitable investments.

Environmental criteria rate the company’s performance as stewards of nature.

Social rating examines its management of relationships with employees, suppliers and customers, and the general community where it operates.

Governance evaluates the company’s leadership with respect to levels of executive reward, and degree of attention to audits and shareholder rights. ESGs are most relevant in the context of the new movement over to environmental activism because they can also help investors avoid companies that would pose more financial risk due to their environmental exposure.

Many mutual funds, brokerage firms, and advisors now offer products that employ ESG criteria. With the advances in their own artificial intelligence and Big Data information management, banks can now correctly assess risk and more easily understand the ESG profile of their clients. It will facilitate extending their involvement in the green finance universe better. Today, sustainable finance mostly involves large, multinational listed companies in the first-world economies since those are the firms that already collect and share information about their green activities.

Environmental risk is increasingly being recognised as a critical global risk, with climate change at the forefront of these concerns. The Intergovernmental Panel on Climate Change (IPCC) predicts that growing environmental pressures are also disrupting economic activities. Tackling climate change is a key priority at the national level. Environmental risk also bears a monetary impact on financial institutions and the assets they manage on behalf of their customers. Weather and long-term or widespread environmental changes also create substantial risk. These can impair the value of any collateral and impair the revenue-generating abilities of client companies on which projections of viability have been made. Adjusting to an environmentally sustainable economy, with changes in public policies, disruptive technological inovations, and shifts in consumer and investor preferences, create further risks. For example, loans and investments in carbon-intensive activities are impacted in the transition to a low-carbon economy by costs and lower levels of profitability.

There is also an expectation from now on for banks to play a “Good Samaritan” role in helping customers and the broader economies to become ecologically sustainable. They need to do this by channeling funds preferentially towards companies engaged in sustainable activities with better pricing and levels of lending and encouraging all customers to adopt more sustainable business practices.

The final thought is that the whole financial sector will be need to be addressing the impact of environmental risk and support. A smooth transition to an environmentally sustainable resilience against the impact of environmental risk must be part of their business and risk management strategies. Financial institutions looking to implement such advanced risk management policies and processes may need to call for expert guidance and management and can call on us for these services.