Is the Banking Sector Doing Enough to Promote Sustainability?

I

When concerns about sustainability in business are being addressed, the banking sector is often far from top of mind. After all, its direct impacts on the environment are limited. Banking is not a carbon intensive industry, in contrast to mining, oil and gas, transportation or manufacturing and banks can only make so much of a difference by cutting back on their use of paper and making their business premises more energy efficient. Yet banks are at the very heart of the economy and are, therefore, positioned to have a bigger impact on sustainability than any other industry, whether they like it or not.  In lending, in underwriting and in investing banks have the power to accelerate the integration of sustainable practices throughout the economy.

Awareness of the key role banks can play in promoting sustainability has been building as sustainability in general is better understood. Both investors and banks themselves are now looking harder at  the indirect impact of banking and not just from the point of view of what banks should avoid but also what they can achieve. Given the centrality of banks to the modern economy they have not just the ability but also the obligation to act. The question is, what are the banks doing about sustainability? And is it enough?

 

II

Having worked in the financial industry for some time I admit to being very skeptical of banks’ statements on sustainability. It has often seemed to me to be just “greenwashing”. I have worked at an asset management subsidiary of a large bank which had signed the UN Principles of Responsible Investing and instructed investment analysts to include sustainability issues in their analyses of bond issues. This was done yet not a single portfolio manager incorporated sustainability into his or her decision making process. Even at a previous employer that had a long standing focus on responsible investing and a large dedicated governance and sustainable investing team, most investment products did not include sustainability as an input to their investment process.

As noted in the UN Global Compact – Accenture CEO Study, “Towards a New Era of Sustainability in the Banking Industry”, the top reason given by bank executives for incorporating sustainability into their strategy is that they believe it will enhance their brand, a far from encouraging motivation as it implies that the image, not the underlying actions, is what counts. A quick look at the website of the American Bankers Association (www.aba.com) seemed to confirm my skepticism as there is no mention of sustainability or corporate social responsibility anywhere. Yet a casual survey of the websites of BNY-Mellon, Citigroup, Bank of America, Royal Bank of Canada, Santander, Bradesco, China Construction Bank and BNP Paribas shows that all of these institutions both publish sustainability reports and (except for China Construction Bank) elaborate at length on their sustainability and corporate social responsibility strategies and the actions they are taking in prominent locations on their websites. These statements and reports go beyond mere platitudes to cite concrete steps the banks are taking.

III

The banks’ own operations offer plenty of low hanging fruit, given the industry’s historically intensive use of paper and the its relatively high electricity footprint from branch networks and data processing. A number of banks are already taking  meaningful steps. For example, BNY Mellon proudly states on its website (www.bnymellon.com/csr) that it has already reached its 2020 goal of cutting its Scope 1 and Scope 2 Greenhouse Gas emissions by 40% from the level emitted in 2008 and has in fact achieved Scope 1 and Scope 2 carbon neutrality. Banks everywhere have moved more services on line, reducing the need for branches and for people to travel to them, and are phasing out paper statements. There is still more to be done, of course, but the industry is already making a difference in the areas it controls directly.

Lending is, of course, the single biggest pool of capital that banks have at their disposal (as noted in the World Resources Institute’s report, “Leverage for the Environment”). Lenders have become accustomed to evaluating the potential environmental risks with projects they finance given the potential liability they face, regulations from banking supervisors and guidance from multilateral institutions such as the World Bank. This kind of risk avoidance is just a start, however. Banks’ loan risk analysis has largely been focused on proposed projects’ immediate impacts on environmental quality but has largely ignored their longer term effect on greenhouse gas emissions. Until recently banks had the excuse that these effects were difficult to quantify. Now resource economists have produced valuations of forest land, pastures, wetlands (“Natural Capital in BC’s Lower Mainland”, David Suzuki Foundation and Pacific Parklands Foundation) and even beaches (“What’s the Value of a Clean Beach”, Boston Globe, July 28, 2018) while carbon markets in the EU and elsewhere have enabled greenhouse gas emissions to be priced (“What Have We Learned from the European Union’s Emissions Trading System”, Wraake, Burtraw, Loefgren, Zetterberg). There is no longer any reason that banks cannot include longer term impact on climate change in their credit analyses, which would in turn force their customers to integrate these considerations into their own decision making.

Banks are financing sustainable projects, with US$127.8 billion funneled to utility scale clean energy projects in 2010 (“Green Investing 2011”, World Economic Forum). While this may sound substantial, it is just a tiny fraction of the close to $9 trillion that banks lent in the US alone in 2010, according to the Federal Reserve Bank of St. Louis (www.fred.stlouisfed.org). In order for banks to step up lending to sustainable projects they will probably need a mixture of stakeholder pressure and regulatory and tax incentives.

The Underwriting function of investment banks requires substantial due diligence (particularly for equities). In theory this gives the banks considerable leverage over their clients since the latter will have to disclose to their banks all potential risks or liabilities of all types that could be material. The due diligence is usually conducted with great care since the bank’s reputation is riding on the success of the offering, particularly in the short term but also in the longer term. The bank’s need to gain market share from its competitors and increase its profits lead to strong internal pressures to ignore potential problems, especially if they are seen as only likely to become obvious in the longer term, which is, of course, the case with greenhouse gas emissions. External stakeholders can work to keep investment banks from pushing these issues under the rug by highlighting the potential for banks to be held accountable for backing businesses that are contributing to climate change.

Sustainability also represents an opportunity for investment banks, one that they are already taking advantage of.  As demand for sustainability focused investment opportunities grows, investment banks are responding by increasing issuance of green bonds and by bringing new green energy companies to the equities market. Green bond and stock offerings still represent only a tiny fraction of the activity in financial markets but should continue to grow as investor demand grows.   According to Reuters (www.reuters.com) global green bond issuance reached a record $163 billion in 2017. Nonetheless this was a mere 2% of total global bond issuance, which Business Insider (www.businessinsider.com) reported to have been $6.8 trillion, also a record.

Those banks that have an Investing arm are particularly well placed to effectuate change. As regulators generally place very tight restrictions on banks’ direct ownership of companies, the channel through which the investing arms of banks can best exert pressure on companies to improve their sustainability practices is the  investment funds that they manage. As shareholders fund managers can sponsor shareholder resolutions and engagement with management to educate and pressure the companies they own shares in to adopt more sustainable business practices.  As discussed below, shareholders are the most powerful of all stakeholders.

IV

So are banks doing enough to promote a more environmentally sustainable economy? Given their central role in the economy and the still negligible portion of it that is sustainably oriented, clearly not. Despite the apparent sincerity of most banks on this set of issues, their sustainability strategies are still very much incipient and far from a core feature of their business models.

What can be done to get banks to do more to build a more sustainable economy?  As noted above, the Accenture/UN Global Compact study found that for 76% of banking CEOs cited “brand, trust and reputation” more than any other cause as one of their top three reasons for taking action on sustainability issues. The banks surveyed also stated that consumers are the stakeholders whom they expect to have the greatest impact on how they manage sustainability. Both of these answers point to a high risk that steps undertaken by banks will be done primarily with an eye to how they appear to the public, rather than how effective they are. After all, while many consumers do prefer to do business with banks and other institutions that have a good reputation for sustainability, they are unlikely to have the resources or the inclination to dig deeply into their banks’ sustainability strategies.  The Accenture/UN Global Compact survey appears to overestimate the readiness of consumers to change banks just because they don’t like their bank’s reputation.

In order to ensure that banks are truly working to build sustainability into their business models, and not just building their brands, other stakeholders need to be involved. “Leverage for the Environment” suggests a number of different avenues for engagement with financial institutions on this subject. Consumers are already applying Reputational Leverage to banks. Activists and environmental groups can reinforce that leverage. And as activists increase society’s awareness of sustainability issues in banking pressure from the public will only increase. But the power to effect real change is in the hands of regulators and shareholders.

Regulators already exercise considerable Policy Leverage over the financial system as they seek to ensure financial stability and protect consumers. In a number of countries, particularly in Europe but also in the US and elsewhere, regulators are now taking further steps  to “create a clearer and more positive regulator environment” for sustainability in finance.  With climate change now posing clear financial risks regulators are increasingly demanding more transparency with respect to banks’ exposures and what banks are doing to mitigate them. Some regulators are also creating incentives for sustainability focused lending and investment policies. Continued engagement with regulators by independent experts and advocations will further this regulatory effort.

Shareholders are best placed to drive true changes in the way banks do business, applying both Bottom Line and Values-Based Leverage. Banks can make cosmetic changes and undertake philanthropy to keep customers happy. Regulators can require more disclosure and can influence bank’s risk-based allocation of capital  (although in the US the current administration is backing away from financial regulation and from efforts to combat climate change). Only the owners of a business can effect profound change in the way it operates.

Given that many, if not most, financial institutions are already implementing a sustainability strategy, they are likely to be reasonably responsive to engagement and dialogue with shareholders. The more confrontational tool of a shareholder resolution may not even be necessary. Shareholders can educate banks on the climate change risks that they face and how to price them, building on the valuation techniques described above, as well as on the opportunities that are being created as society moves towards a less carbon intensive economy. In particular, most financial professionals continue to believe that lending, underwriting and investing in a sustainable way usually detracts from the bottom line.  Expert shareholders, armed with data on key topics such as the costs of ignoring sustainability and the superior risk adjusted long term performance of sustainable investment strategies, can go farther than any other stakeholders in ensuring that banks lead the way towards a more environmentally sustainable economy.

 

SOURCES

Academic Publications:

  • “Accounting for Risk: Conceptualizing a Robust Greenhouse Gas Inventory for Financial Institutions” (World Resources Institute, 2009)

  • “L’Economie des écosystēmes et de la biodiversité” (TEEB, Sukhdev et al, 2010)

  • Evolutions in Sustainable Investing (Krosinsky, Robins, Viederman); John Wiley & Sons, 2012

  • “Green Investing 2011“ (World Economic Forum)

  • “Leverage for the Environment” (World Resources Institute, 1998)

  • “Natural Capital in BC’s Lower Mainland” (David Suzuki Foundation, Pacific Parklands Foundation, 2010)

  •  “Towards a New Era of Sustainability in the Banking Industry” (UN Global Compact – Accenture, 2011)

  • “What Have We Learned from the European Union’s Emission Trading System” ( Wraake, Burtraw, Loefgren, Zetterberg, 2012)

Other sources:

  • Federal Reserve Bank of St. Louis

  •  “Global bond issuance hits record $6.8 trillion in 2017” (Business Insider, December 17, 2017)

  • “Global green bond issuance rose to $163 billion in 2017” (Reuters, January 29, 2018)

  • “What’s the value of a clean beach?” (Boston Globe, July 29, 2018)

Bank websites:

 

——————————

White Pine Advisory LLC (“White Pine”) is a registered investment advisor. Advisory services are only offered to clients or prospective clients where White Pine and its representatives are properly licensed or exempt from licensure.

The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor.

The views expressed in this commentary are subject to change based on market and other conditions. These documents may contain certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.