Retooling the bank for sustainable lending
October 22, 2021
October 22, 2021
In the world of asset management, investing with environmental, social, and governance (ESG) considerations in mind has become mainstream. Now, impetus is starting to build for sustainable lending as countries around the world redouble their efforts to address climate change and build sustainable economies that work for everyone in the wake of COVID-19.
Yet, even with momentum building behind sustainable finance, banks are taking a cautious stance on the topic. According to BankTrack1, 50 of the 60 banks it analyzed worldwide were classified as laggards in terms of sustainable financing. Their hesitance may be explained by a range of factors, from a lack of regulation and standards to concerns about payback periods, risk assessment and customer maturity.
Sustainable-linked lending skyrocketed from $5 billion in 2017 to $120 billion in 2020.2
Banks’ concerns about green banking are not without merit, yet those that are not proactive may soon find themselves at odds with shareholders and regulators. Subsidiary finance or public incentives are likely to drive significant demand for sustainable lending in years to come. In addition, banking customers are becoming subject to increasingly strict industry-specific regulation such as the EU’s Corporate Sustainability Reporting Directive (CSRD).
Also consider the recent resolution by the European Banking Authority3 that banks in the EU should publish a “green asset ratio” (GAR) from next year. It will let investors easily compare banks by the amount of climate-friendly loans, advances and debt securities on their balance sheet as a proportion of total assets.
Institutions that are unable to cope with these ESG-related regulatory developments will face increased pressure to change. They may see higher credit risks, unfavorable lending terms and weaker profitability as ESG risks become concentrated in their loan books.
But on the flipside, banks that forge a bold sustainable finance agenda will develop the knowledge and skills in their lending practices to thrive in the sustainable lending market of the future. This, in turn, could help them to outperform the sustainability laggards as investors, regulators and customers scrutinize their ESG behavior and credentials more closely in years to come.
The rise of green lending is an inflection point for banking.
ESG impacts the entire lending process and value chain. Banks have made significant investments in straight-through processing, automating document collections, developing e-documentation and reducing collaterals. Moving to green lending carries the risk of falling back on cumbersome manual interventions.
Leading banks will thus include ESG considerations in lending decisions, while building on the investments they have made in automating and speeding up credit processing. They will look at transforming their lending value chains, building ESG data platforms and reskilling lending practice teams.
Green finance remains in its infancy. However, banks that seize the opportunity to finance the sustainability agenda will be able to stay ahead of regulation, capture significant growth opportunities in a new market and strengthen public trust. Read our report to learn more.
What is sustainable lending?
Sustainable lending, like sustainable investing, means that environmental, social, and governance (ESG) considerations play a central role in credit decisions. A sustainability-linked loan will typically focus on giving the borrower incentives to meet ESG performance objectives. The conditions of the loan will be tied to the achievement of ESG metrics such as carbon emissions or workforce and board diversity.
What’s driving the sustainable lending trend?
In the wake of the COVID-19 health and financial crisis, banks face growing calls to play their part in addressing today’s environmental and social concerns. Some of the forces driving the rise of sustainable lending include:
What green lending products can banks offer?
How can banks transform their lending chains for sustainability?
A medium-term ESG roadmap might focus on these steps:
How can banks’ lending practices prepare for sustainable lending?
Many banks’ credit professionals have not been trained to assess lending terms and conditions through the lens of sustainability, nor do they have skills in analyzing ESG data. We suggest three actions to consider:
How can banks prepare their data platforms for sustainable lending?
We recommend these possible steps:
References
1. Banks and Fossil Fuel Financing, BankTrack, 2021.
2. Environmental, Social, And Governance: How Sustainability-Linked Debt Has Become A New Asset Class, S&P Global Ratings, 2021.
3. EBA advises the Commission on KPIs for transparency on institutions’ environmentally sustainable activities, including a green asset ratio, European Banking Authority, 2021.