Sustainability in Finance - A Banking Sector Perspective
Posted in Finance Articles, Total Reads: 1342
, Published on 05 February 2016
The crisis that the world faces today is greater than just ecological. There is a huge disparity in the wealth distribution not only among individuals but also nations. Resources are being indiscriminately extracted from the Earth without paying any heed to the replenishing capacity of the planet. The reason for all this: the insatiable desire of the modern world to consume more and more. And as there is a demand side to this there is a supply side to it as well; enter the Businesses, Industries and Corporations. Businesses are striving to outperform each other by any means possible, creating demand and even need where there is none.
The world today acknowledges that the right way forward is the one in which fewer resources are exploited, extracting just enough which can be naturally replenished by the planet and which aims for equitable distribution of resources. However, the traditional mindset is that there are always trade-offs between financial and sustainable performance. There is a notion that moving on to such practices would hurt businesses’ profitability and hamper economic growth.
Businesses are the key drivers of growth, development and progress. Banking and Financial Institutions are the engines that fuel these drivers. Thus if the world were to move towards sustainability centric living, businesses would have to act as pioneers for the cause. Banks and Financial Institutions owing to their pecuniary capabilities are vital for existence of businesses. Thus Banks and Financial Institutions are the key protagonists in this necessary shift towards sustainability. [Amalric Franck, 2005]
Switching over to more sustainable practices and acting in the interest of the society and the environment makes business sense as well. Companies which have done so have experienced positive outcomes in terms of financial performance. Research suggests that financial performance has a positive correlation with a companies’ sustainable behaviour. [Martínez Ferrero et.al, 2013]
Organizations have realized that the only way forward is for the environment, the society and the economy to progress together. Owing to this realization, sustainability conscious organizations are moving from the traditional single bottom-line approach that focuses solely on profits, to a triple bottom-line approach which focuses on People, Planet and Profit; from wasteful extraction to waste-free use and renewal of natural resources; from linear models that abuse the ecology to circular models that are relatively benign; from focusing on labour productivity to focusing on resource productivity. The story of Interface Inc. and its founder Ray Anderson is the quintessential story of a company which has performed exceptionally well financially while significantly bringing sustainability to the core of its business operations. [Interface Sustainability]
Interface, the world’s largest manufacturer of Carpet Tiles experienced increased profits year on year as they turned towards more sustainable practices. [Tommi Lampikoski, 2012] Interface uses concepts such as bio-mimicry, closed-loop systems and renewable energy in its business operations and makes sustainably conscious decisions. [Interface Sustainability] E.g. the company willingly accepts any discarded carpet tiles and either recycles them or ensures that they are disposed off in an eco-friendly manner.
In 1994, Ray Anderson [Common Dreams] set the target for Interface to become a zero pollution company by year 2020 and decided to shift the focus on resource efficiency and to follow a circular model instead of a linear one. In practice this meant the company decided to use just enough resources which could be replenished naturally. Anderson was dubbed as ‘America’s Greenest CEO’ by the Forbes Magazine in 1999. All of this was achieved while being profitable. The company was able to increase its profits by 200%, its sales by 75% in a time span of around 12 years while bringing down its net greenhouse gas emissions by 82%, decreasing its reliance on fossil fuel consumption by 60% per production unit and increasing its recyclable and renewable material usage by 25%. [Ray Anderson, "The Business Logic of Sustainability."]
Need for Banks to adopt Sustainability
The world’s top 10 banks jointly possess assets that outweigh the GDP of 8 of the world’s largest economies by around US $3.3 trillion. (Refer Graph: Comparison of world’s top 10 banks and GDP of top 10 economies)[SNL:Data Dispatch] Banks possess a great deal of financial muscle which often dictates policy making around the world. This can be leveraged for building the case and providing the necessary push for sustainable development.
The changing times have led banks to understand that there are both risks and rewards associated with the environment.
As legislation on environment and social issues such as, ‘The Indian Fisheries Act’, ‘The Water (Prevention and Control of Pollution) Act’, and ‘The Environment (Protection) Act’, becomes more robust, borrowers face greater risks on sustainability related issues which in turn might expose the lenders to risk of default and turning up Non-Performing Assets.
Since the world is increasingly becoming aware about sustainability there is a wider scope of sustainability related financial instruments which provides greater opportunity for banks to earn profits.
The increase in awareness about sustainability related issues among the general public has caused people to look more favourably towards sustainable businesses. Therefore, it makes perfect sense for a bank to invest in sustainable businesses and in being a sustainable business itself, thus enabling it to enhance its brand perception.
Thus, the need for banks [IISD Home | IISD; Benjamin J. Richardsoni, 2005] to grow more conscious stems from:
- Responsibility towards the society owing to their financial and political muscle.
- Default Risks associated with borrowers being exposed to more robust sustainability related legislation.
- Opportunities in the form of new sustainability related financial instruments.
- Improving brand perception amongst the environmentally and socially conscious public.
Inhibitions of Banks in adopting Sustainability
There is a perception that if a bank takes on the Sustainability route it would be limiting its potential customer base as the customers clearing the sustainability criteria would certainly be lesser. [Nigamananda Biswas, 2011]
The benefits from Sustainability related initiatives are usually observable in the long run. Adding to that is the short sightedness of management, owing to their relatively shorter terms. The vested interests of showing inflated profits or meeting targets in the short run are enough to disincentivize the management. Therefore there are very few takers for the sustainability path.
Legislations and regulations regarding adverse social and ecological impact are still quite ambiguous and flexible in a large part of the world. Owing to all of this Sustainability Impact Assessment is at times viewed as an added contributor to risk.
Since Environment and Social Impact Assessment require specialized skills, banks consider turning towards sustainability as an added cost due to the need for them to hire specialized talent.
Roles that banks can play in Sustainable Development
The role of banks in Sustainable Development can be divided into three parts:
A) Internal Role
Banks may strive to improve internal practices so as to be more resource efficient. For this banks may consider implementing Environmental Management Systems to achieve more efficient environmental and social impact of their business operations.
Reducing their paper and energy consumption, using recyclable objects, having buildings which are more energy efficient and hence LEED certified, focusing on well being of internal stakeholders could be some measures that the banks could adopt.
Reporting on Sustainability related issues such as conducting environmental impact assessment and social impact assessment on its borrower’s projects and disclosing the net impact of the bank’s actions.
B) Micro Role
Banks, owing to their large reach may help improve the overall sustainability related habits of their customers. E.g. Banks may incentivise customers who spend on environment friendly products using their credit cards, or they may encourage customers to use electronic payment systems. [Barry Christine et al., 2009]
Incentivising customers for switching to electronic forms of payment would not only help save paper but also associated costs incurred in transferring that paper based monetary payment instrument geographically. According to a research’s findings there is substantial scope of saving resources by just switching over of 10% of total paper cheque transactions worldwide to electronic forms of payment. (Refer Table: Resources conserved by converting 10% of paper checks to electronic ones)
C) Macro Role
Banks may pledge their allegiance to the sustainability bandwagon by adhering to the Codes of Conduct issued by international organizations such as the Equator Principles [Amalric Franck, 2005], which not only provide a framework for banks to function but also give clear guidelines keeping Sustainability at the forefront of operations.
Issuing of financial instruments focussing on Sustainability [Marcel Jeucken, 2001;Sarita Bahl, 2012] is another step that banks may take. Some examples are:
- Sustainable Loans
- Sustainable Risk Assessment
- Sustainability Funds
- Sustainable Leasing
- Environmental Insurance
- Environmental Advisory Services
- Environment Venture Capital
This article has been authored by Rahul Verma from XLRI Jamshedpur
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Bahl, Sarita. "The role of green banking in sustainable growth." International Journal of Marketing, Financial Services and Management Research 1.2 (2012).
Barry Christine, and Judson Murchie. "Global Cash Management: Going Green." BottomLine.com. Aite Group, 17 May 2009. Web. 20 Oct. 2015.
Biswas, Nigamananda. "Sustainable Green Banking Approach: The Need of the Hour." Business Spectrum 1.1 (2011)
Eccles Robert G.and George Serafeim. "Sustainability in Financial Services Is Not About Being Green." Harvard Business Review, mai (2013).
Jeucken, Marcel. "Sustainable Finance and Banking: Slow Starters are Gaining Pace." http://www. sustainability-in-finance. com/ifi. pdf (2001).
Lampikoski, Tommi. "Green, Innovative, and Profitable: A Case Study of Managerial Capabilities at Interface Inc." Technology Innovation Management Review 2.1 (2012).
Martínez Ferrero, Jennifer, and José Valeriano FríasAceituno. "Relationship between sustainable development and financial performance: international empirical research." Business Strategy and the Environment (2013).
Richardsoni, Benjamin J. "The Equator Principles: the voluntary approach to environmentally sustainable finance." European Energy and Environmental Law Review 14.11 (2005): 280-290.
Schmidheiny, Stephan, and Federico J. Zorraquin. Financing change: The financial community, eco-efficiency, and sustainable development. MIT press, 1998.
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