By Bob Souster

With increasing public concern about the adverse effects of climate change, there has been a shift in the demands of stakeholders of banking organisations, including customers, shareholders, regulators and the communities in which they operate. While customers once focused on safety and security of deposits and receiving a reasonable return on their deposits, many now consider whether they are dealing with providers that act in an environmentally positive manner.

For many shareholders and potential investors, capital allocation decisions are influenced by the sustainability policies of companies in which they invest. Governments and regulators are turning their attention away from purely financial performance metrics and towards a broader range of indicators which help them to assess companies in respect of their environmental, social and governance (ESG) performance. These changes are permanent, creating new demands, and these will continue to evolve in the future. They will have to be taken into consideration when deciding what information to provide to stakeholders, how the information should be provided and the support necessary to ensure that the information is credible and reliable.

ESG

Though often dressed up in different words and phrases, banks have been familiar with the need to implement sound ESG policies for some time. Even before the Paris Agreement was signed in 2016, many banks proclaimed their commitment to corporate social responsibility (CSR) and some financial institutions were even founded on the basis that they would operate ethically, with a strong social and environmental dimension to their mission and objectives. Examples include Banca Etica (Italy) and Triodos Bank (Netherlands). In 2021, a United Nations initiative prompted the formulation of the Principles for Responsible Banking, initially signed by 129 founders and now supported by over 300 organisations. There is no doubt that ESG is the way to go.

Banks have a powerful role to play in promoting global sustainability and many commentators agree that they should accept a moral obligation to play their part. A bank can be a force for good in many ways, through lending, investing and advising clients that are committed to noble social and environmental goals. But this can create new problems and challenges, some of which must be managed extremely carefully. Even with the very best intentions, a bank may find itself supporting a client that purports to be a sustainable company, only later to discover that it is anything but sustainable.

The stark reality is that the bank cannot be technical experts in every field in which its clients are involved. External technical support from experts is an imperative in many fields of banking operations.

Too Much Information, Not Too Little

Consider a bank that has been approached to finance a (fictitious) airline which claims on its website, ‘We are Malaysia’s cleanest airline and we care deeply about the future of our planet and the people who inhabit it. The carbon emissions on our flights from Kuala Lumpur to Johor Bahru are 38% less than typical operators on the same route’. This apparently compelling reason to invest on environmental grounds could be challenged on several grounds:

  • Does the company use the same aircraft all the time or has it chosen the most advantageous example, and is it likely to change the aircraft it uses in the future?
  • How has the company calculated the 38% figure and can it be verified by a reputable, independent expert?
  • Are the airlines operating the route typical of the industry? For example, do current operators fly aircraft with exceedingly high emissions, thereby rendering the figure less meaningful?
  • Should the bank be encouraging passengers to fly at all; is it more sustainable for travellers to drive or take a bus or a train?
  • What are the social costs of lending to this company, as more flights will result in more noise, more traffic to and from the airport and adverse effects on agricultural businesses situated near the relevant airports?
  • Does the airline use ‘dirtier’ planes on other routes and is it offering favourable information simply to exaggerate its environmental credentials?

In such cases, it is up to the bank to assess whether the claims and credentials of the client are sound or an example of crass ‘greenwashing’. Its officers can conduct endless research to establish facts that support or disprove the information provided. But even when such due diligence has been carried out, it is possible that other experts might be consulted with different conclusions, based on different assumptions.

The Social / Environmental Dichotomy

Put simply, the beneficial environmental actions of a bank can have an adverse social impact and vice versa. The simplest example of this is reflected in the duties of a bank to clients that have a negative environmental footprint. These include traditional industries that cannot survive in the short-term without creating pollution or depleting the earth’s resources. Yet, the same industries often employ hundreds, sometimes thousands of workers, creating income and wealth for the communities in which they operate. The bank has a duty to its client and a broader duty to the environment and these obligations are difficult and often impossible to reconcile.

The problem is compounded by the fact that experts often disagree with one another, as demonstrated by ongoing controversies in the Malaysian palm oil industry.

What and How to Report to Stakeholders

In managing their interfaces with stakeholders, it is up to banks to decide how they report on ESG issues, as this can have important ramifications on how they are perceived, not least reputational risk.

There is no shortage of approaches and models available. Some organisations have adopted an integrated reporting framework, based on six criteria (or ‘capitals’). An alternative is adopting a broader-based model such as the Global Reporting Initiative comprising universal standards (applicable to all) and sector-specific standards.

In 2023, the International Ethics Standards Board for Accountants launched a series of roundtables to gather intelligence on how best to approach these issues. It emphasised the importance of developing fit-for-purpose, globally applicable ethics standards (including independence) to support transparent, relevant and trustworthy sustainability reporting. Additional, ongoing work is being carried out by the International Sustainability Standards Board in this respect.

For banks going about their everyday work, these issues present difficult challenges. It is reasonable to conclude that the boards of banks want their organisations to be good corporate citizens, aligning themselves with the desires of the majority of their stakeholders, presenting information on their performance as an authentic representation of their best efforts to support their clients and society as a whole.

Robert (Bob) Souster is a Partner in Spruce Lodge Training, a consultancy firm based in Northampton, England. He lectures on economics, corporate and business law, management, corporate governance and ethics. He is the Module Director for ‘Professional Ethics and Regulation’, a core module of the Chartered Banker MBA programme at Bangor University, Wales.