There is a growing awareness by banking and finance companies to adopt ESG criteria (Environmental, Social and Governance) in their business strategies. This involves actions related to environmental concerns, such as climate change, resource scarcity; social issues (e.g., human rights violations), and governance matters, such as corruption and board diversity. This awareness catches the eyes of investors in those businesses on those companies whose operations show commitment and responsibility in these areas.
These entities are under pressure from regulators, and shareholders to adopt more responsible, ethical, and sustainable business practices. For others its anticipated regulation, reputational risks, social concerns, talent attraction, branding, and increased transparency.
In this context, it’s important to differentiate it from CSR. Corporate Social Responsibility is a framework of company’s values, culture, and sustainability plans. It’s largely self-regulated, internal, and driven by best practices with no official or widely accepted standard.
Both are concerned with a company’s impact on society and the environment, ESG however is a criterion that investors use to assess a company, its risks, ethics and determine if they are worth investing in. It’s replacing CSR because it has a tangible and measurable positive impact with focus on quantitative results. Think of ESG, as evolution or CSR 2.0.
It’s not just large companies. Even regional, local, small to mid-size banks, credit unions, cooperatives, micro-finance, or their customers are doing so. Over 80% of the world’s economy is run by small to medium-sized businesses, which holds over 60% of banking deposits. ESG standards provide a way to benchmark their performance and identify areas where they can improve. They help businesses to track progress in these areas and compare against other companies.
SME financial institutions can raise the bar by following ESG standards and lending more to businesses that meet or have ESG standards in place. Conversely, they can reduce/restrict loans to companies with none.
By promoting digital banking, they can have fewer branches and reduce customer trips to the bank, so it’s good for the environment. It helps millions who are unbanked and underbanked, which counts for the social aspect. By creating a board that’s diverse, inclusive, and robust compliance systems, the governance aspect can be addressed.
A study by MSCI found that companies with high ESG scores outperformed those with low scores by 2.5% per year between 2010-16. Similarly, companies in the S&P 500 Index with strong ESG ratings outperformed those with weak ratings by 3% per year between 2007-16.
There are several reasons. One is that investors are putting their money into companies doing well regarding ESG issues. It shows investors have taken a stance for responsible investing or impact investing. Another is that companies with strong ESG ratings tend to have better risk management practices. This means they are less likely to be hit by adverse events, such as environmental disasters, lawsuits, social protests, and labour strikes. Lastly, companies with higher ESG ratings tend to be more innovative and efficient.
As part of this movement, financial institutions are also stepping up with the “Net-Zero Banking Alliance,” and pledged to reach net-zero carbon emissions across their lending portfolios by 2050.
There are over 600 ESG reporting standards that financial institutions can choose to adopt. The most popular is the Global Reporting Initiative (GRI); others include the ISO 26000 and the Sustainable Banking Principles of the IFC.
However, there are some challenges with implementing ESG standards. These include the need for technical expertise, the risk of greenwashing, distraction, additional compliance efforts, and costs. Furthermore, there is no standard in emerging markets, different types of reporting, standards, and frameworks in the space.
Choosing the right ESG standard should be done carefully based on the location, resources available, and long-term business goals. Complying with your desired standard will mitigate risks, build trust with stakeholders, and improve reputation.
What are your thoughts on ESG?
Six steps to implementing ESG
- Conduct a materiality assessment
- Establish your baseline
- Determine goals
- Conduct GAP analysis
- Develop your ESG roadmap
- Put the plan into action and measure KPIs