Recently, Standard Chartered Bank announced a new environmental, social, and governance (ESG) linked cash account for corporate banking clients that will reward them for meeting ESG targets.1 Why have ESG considerations become so critical for the corporate banking sector today? The truth is, it is because these factors can no longer be ignored as the world hurtles towards environmental disaster, and contends with corruption, injustice, inequality, and discrimination. In addition to political action on ESG issues, there is now greater emphasis on corporate accountability and responsibility on these fronts. Banking is no exception. ESG risks and opportunities are key focus areas for financial organizations as they hold not just ethical value but are also linked with improved performance.
Why ESG Matters
There is diminishing tolerance for inaction or lack of responsibility on ESG matters, and financial institutions that fail to meet these standards are facing the brunt of regulatory fines, as well as public anger. For example, when it emerged that a large global bank was one of the major financers of a controversial pipeline project, the institution faced significant backlash from environmental activists, indigenous groups, and social justice organizations. There were customer protests and calls for divestment with high profile stakeholders expressing their concerns about the bank’s financing strategies. While there were no direct financial or regulatory consequences at that time, the bank did suffer significant reputational damage and had to reassess and adjust its policies with ESG in focus.
Today, world financial institutions are prioritizing climate risk in their ESG strategy. This is driven by strong public interest as well as emerging regulations. But understanding and addressing of social risk drivers and more nuanced environmental risks like biodiversity risks remains a challenge. Almost 70 percent of banks have not thoroughly evaluated biodiversity risks.2
The ESG Regulatory Landscape
For financial regulators, ESG is a priority because environmental and social factors can pose serious physical and transition risks and threaten the stability and growth of the financial sector.3 The regulatory landscape is still evolving, though greenwashing or incorrect sustainability claims of products and services is a focus area for regulators.
In the U.S., The Securities and Exchange Commission (SEC) is working on rules pertaining to greenwashing in investment funds. It is expected to also finalize a rule to strengthen regulations around investment funds disclosures and investment advisors’ ESG investing strategies. The European Union’s (EU)Sustainable Finance Disclosure Regulation (SFDR) requires financial institutions to disclose how ESG factors are incorporated into their investment decisions and risk management strategies. The EU Taxonomy Regulation is part of the European Green Deal that provides a classification system for determining if an economic activity is environmentally sustainable. Banks must assess and align their activities with this. Global Reporting Initiative (GRI) standards are used for sustainability reporting and are widely adopted by banks to disclose their ESG impacts. There are several other ESG regulations and standards like the Task Force on Climate-related Financial Disclosures (TCFD), Principles for Responsible Investment (PRI), and the Dodd-Frank Act Section 1502, and the International Sustainability Standards Board that recently published its standards for company disclosures.
Banking ESG Strategy
Banks and financial institutions must now focus on effectively integrating ESG principles with their strategy and operations. In fact, according to a KPMG survey, 63 percent of banks increased their ESG budgets in 2023 compared to the previous year.4 Unfortunately, most respondents also said that the main challenges they face with integrating ESG risks into their risk management strategies were the unavailability of data, rapidly evolving regulatory requirements, and the shortage of skilled staff.
To effectively navigate risks and opportunities under these circumstances, banks need a robust technology platform that is aligned with their business strategy, overall ESG goals, and revenue growth and profitability targets. With a powerful ESG-integrated system in place, banks can accelerate their ESG journeys and improve their own sustainability ratings. Banks can incentivize corporate customers to accelerate and prioritize their own sustainability journeys like Standard Chartered did. Banks can work with third-party assessors and ratings agencies to ensure accurate assessments and help chart an incentive program for corporate customers. A powerful technology solution can also leverage sustainability parameters to personalize pricing for customers.
Today, banks are looking for innovative ways to connect meaningfully with their customers and partners. Integrating ESG principles and targets into their overall business strategy is a good way to show stakeholders the organization’s commitment to these causes. And innovative offers that incentivize customers for their ESG-related progress can help drive their sustainability-oriented behavior, leading to customer delight and engagement. Banks can incentivize future deals based on the corporate customers’ ESG ratings, and even offer Sustainability-as-a-Service. Best of all, banks do not need to overhaul their legacy cores to incorporate ESG principles. They can choose to work with a specialized partner who can deploy a robust, cloud-native, microservices-based middleware solution over their legacy core that can power the ESG integration.
Today the impact of climate change can no longer be denied, and human inequity is growing. This is a time for urgent action on multiple fronts to ensure a safer, more stable, and inclusive future for humanity. The banking sector must take the lead in ensuring ESG goals are met for a sustainable future. As stakeholder scrutiny and corporate accountability grows, and the ESG regulatory landscape continues to evolve, banks must adopt a technology-powered strategy to take their ESG strategies forward.