How to best navigate the ESG challenges in banking

May 23, 2024 | 10:45
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Environmental, social, and governance (ESG) considerations have become increasingly integral to investing and corporate strategies across industries, especially the financial sector.

The banking sector, as a critical pillar of the global economy, has not been left untouched from ESG. However, while many banks have made commitments to its principles, they face significant challenges in implementation, often compounded by the allure of greenwashing.

How to best navigate the ESG challenges in banking
Samir Dixit, global head ACORN Management Consulting

Greenwashing, is a form of advertising or marketing spin that deceptively uses green PR and green marketing to persuade the public that an organisation’s products, goals, or policies are environmentally friendly. Companies that intentionally adopt greenwashing communication strategies often do so to distance themselves from their environmental lapses or those of their suppliers.

Let’s just get one significant fact right before we deep dive into anything to do with banking. Banks fundamentally only know and focus on two things and two things only: mitigating risk and making profits.

ESG in banking poses a big challenge for both of these focus aspects. It is extremely challenging for the banking sector given the broad spectrum of challenges that come with compliance, including climate change risk mitigation, social responsibility, and ethical governance.

For banks, integrating these considerations into their operations involves not only aligning their lending and investment practices with sustainable goals, but also addressing crucial changes to internal policies and practices to ensure responsible business conduct.

Some of the crucial challenges for banks in embracing ESG is the complexity of assessing and managing risks across their highly diverse portfolios as climate change poses multifaceted risks, from physical impacts such as extreme events to transition risks originating from the intended shifts towards a low-carbon economy, which constantly shifting risk dynamics. Banks therefore have to develop dynamic and robust risk assessment frameworks to evaluate and mitigate these risks effectively.

With the dynamic risk frameworks comes the real risk of ensuring alignment with social and governance factors requires banks to scrutinise their relationships with various stakeholders, including employees, customers, communities, and regulators. Issues such as diversity and inclusion, human rights, and data privacy are increasingly under the spotlight, demanding proactive measures from banks to address them.

Making matters worse for the banks among all these challenges is the greenwashing which poses as a significant roadblock towards ESG integration within the banking sector.

How to best navigate the ESG challenges in banking
Stakeholders often seek more clarity on bank commitments to ESG-related matters, Photo:

It is not all that difficult for a bank to pretend to be doing things than be actually doing the integration. Banks are known for greenwashing efforts by way of sponsoring various ESG programmes which help banks convey a false impression of environmental responsibility through marketing or public relations efforts, while not substantively addressing any real or significant ESG concerns arising through their own business operations.

A good test to see whether a bank has really made substantial business changes to address these issues would be for the regulator to closely audit and examine the banks frameworks and processes pre and post their claimed ESG integration and one would likely see a different picture than what the banks claim it to be. The answer as to why the banks continue to engage in greenwashing is rather simple.

Banks engage in greenwashing for reputational enhancement, competitive positioning, and financial incentives tied to ESG performance. By presenting a facade of compliance, banks can continue to attract investors and customers seeking ethical and sustainable options, without making substantial changes to their practices and keep regulators at bay.

One of the most common greenwashing tactics employed by banks is the selective disclosure of ESG-related information. They may highlight certain initiatives or achievements while hugely downplaying or completely omitting negative aspects of their operations. Banks also use vague or ambiguous language in their disclosures, making it difficult for stakeholders to find out the true extent of their commitments.

Addressing genuine compliance and eliminating greenwashing in banking requires greater transparency and accountability within the banking sector. Regulators play a crucial role in setting clear ESG disclosure standards and enforcing compliance to prevent misleading practices. Investors and customers also have a responsibility to scrutinise banks’ ESG claims and hold them accountable for their actions.

Furthermore, banks must demonstrate a genuine commitment to the principles by integrating them into their core business strategies and operations. This involves embedding sustainability considerations into risk management frameworks, product development processes, and corporate governance structures. Collaboration with stakeholders, including civil society organisations and industry peers, can also foster accountability and drive meaningful progress towards sustainability goals.

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By Samir Dixit

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