Environmental, social, and governance (ESG) is a term now familiar across banking as the industry works to become more sustainable and appealing to environmentally and socially responsible consumers.
It is easy to communicate ESG goals, but it is much more challenging to follow through. Leaders from community banks can use the following practical points to help achieve ESG objectives, with the tools they have available.
Evaluate data strategy: To support sound decisions, banks should integrate ESG data into both their customer experience and risk management strategies. While data may be incomplete now, institutions already have the information they need while accurate data builds up over time.
How ESG risks affect the calculation of economic and regulatory capital, along with capital adequacy, is the core question that banks must answer. The first step is to assess ESG exposure as it relates to a bank’s entire operation, including how their ESG risks may correlate with other industries within their supply chain.
Once these risks are identified and assessed, control measures can be developed to manage ESG objectives, including portfolio reassessment and operational risk management. And as data builds up over time, community banks can adapt their processes in accordance with analysis of that data. Remember, this data must be auditable – even if that is not yet a requirement, as it will be within the next two years.
Manage climate risk: ESG is not just about day-to-day decisions around sustainability – it’s also understanding the importance of climate risk scenarios and stress tests, which are quite complex. Plus, there is the looming threat of regulatory requirements, such as the widely adopted guidelines defined by the Taskforce for Climate-related Financial Disclosures (TCFD).
President Biden issued the Executive Order on Climate-related Financial Risk in 2021, which seeks the development of a strategy for mitigating climate-related financial risk. While this order did not create any enforceable rules, it signifies that this topic is top-of-mind for the administration.
Before beginning analyses and stress tests, banks must ensure they adequately train and update their staff on how to identify and measure new types of risks. This will allow them to assess the status quo in terms of the potential impact of both physical risk, such as droughts or supply chain breakdowns, and transition risks, such as new regulations.
After these achievable steps are taken, banks must then take initiative to integrate this into their risk management. Once an adequate structure is in place, analysis of results and stress tests can effectively support decision-making.
Offer green finance: Community banks are uniquely positioned to help others achieve their own ESG goals through green finance initiatives. Supported by API-driven platforms that allow lenders and businesses to embed financing options into their offerings, green finance can be extended to businesses and individuals.
One example is solar panel installation, which many homeowners and business owners are now embracing across the U.S. Utilizing various data sources, the energy yield of panels in a specific location can be inferred. When combined with a customer’s finances, accessed with consent from the customer’s bank, the data can be used by a solar company to provide financing options. The bank gets to provide a “green loan” with a low chance of default.
Embrace cloud migration: Many banks tout their ESG wins while their on-premises data centers create massive carbon impacts. If community banks truly want to drive change, they must embrace cloud migration and reduce their physical IT infrastructure.
Cloud infrastructure allows banks to run environments only when required, such as disaster recovery, so energy use declines. Moreover, from a corporate governance perspective, cloud providers have invested extensively to establish cybersecurity expertise and protections, which ensure that data risk remains low.
Community banks are well-positioned to be the changemakers in the ESG space. The key is that banking leaders consider the quality and achievability of their ESG initiatives, not just speed of announcing plans. With these strategies in place, they can generate a wave of pressure across the industry and will be rewarded by their customers for driving this important change.
Iain Scott is head of post trade, treasury and capital markets at Finastra.
