Modern finance and banking must integrate a new green — one that has nothing to do with the color of the American dollar bill. Organizations within the industry are being called upon to address climate change through policies, investment practices, and sustainable banking.
These burdens come when the nation — and the world — is looking to change. The disruption of the COVID-19 pandemic created new normals in all sectors, and leaders and citizens wonder if returning to old ways following the global health crisis would be a wise or sustainable move.
One of the drivers behind a desire for ongoing change is the climate crisis. According to the National Oceanic and Atmospheric Administration July 2021 was the hottest month on record at that time for planet Earth. Wildfires, record-breaking rainfall in many areas, and rising sea levels lead to growing concerns, and those concerns are turning into action.
Governments are initiating regulations, pushing banks and other financial organizations to enact sustainable practices. Discover more about these practices and the current transition in financial sectors below.
How Financial Institutions Enact Sustainable Banking Practices
Supporting Partnerships With Regulatory Organizations
One essential strategy for sustainable banking is collection action between regulators and others within the industry. Banks and other financial organizations get a say in those policies by partnering with regulatory agencies and demonstrating a sincere desire to enhance sustainable policies. They can bring expertise and background to the table to help regulators understand changes’ business and economic ramifications and find the right compromise between sustainability and support for financial concerns.
Helping to Direct Private Sector Financing with Sustainable Banking
Sustainable investing, such as socially responsible real estate investing, can amplify positive policies enacted by governments, bringing practical change to financial sectors. But environmental integrity is a top-down asset. So financial institutions must model it and encourage private investors to do the same.
Moving Toward Green Agendas With Financing
Banks can help push forward green agendas by choosing to finance efforts with those goals. Ultimately, corporate responsibility for sustainability is shared across industry sectors, and banks can support partners by backing the appropriate measures.
Impact of Low-Carbon Transition on Asset Values
The move to reduce carbon footprints across all sectors around the globe is changing asset valuation for banks. During this period, financial organizations may be looking for sustainable banking opportunities such as alternative energy investments, but they must also be mindful of assets in transition that may become stranded.
Examples of Investment Needs During the Transition to Sustainable Banking
Investment needs during the transition range from supporting new infrastructure to backing products and projects that drive positive outcomes for the environment. Some examples include:
- Sustainable energy, including infrastructure such as wind farms and solar panels as well as R&D on innovative solutions
- Upgrading existing infrastructure, particularly in fields such as manufacturing, to support ongoing functionality with a reduced carbon footprint
- Products and services that move communities and nations away from reliance on fossil fuels, such as electric vehicles
Financial Factors Impacted by the Transition
The evolution during this transition has an impact on financial factors, including:
- Operating expenses are likely to increase — at least in the short term — for organizations that work to enact change. Research and development, implementation, and training are just some efforts that could drive up operating costs and impact asset cash flow during the transition.
- Depreciation and amortization of equipment and assets that don’t align with sustainable practices. The value of these assets may drop faster than initially planned, creating monetary stress that ripples up through financial organizations.
- Costs of financing can create burdens for investors and other businesses as they seek to generate sustainability while maintaining current cash flow and other financial goals. As a result, investment financing may be an option that more partners turn to during this period.
Going increasingly green means abandoning long-term infrastructure and processes, stranding once valuable assets. As a result, transportation, oil and gas, and manufacturing are all at risk, and assets in these sectors may quickly become liabilities soon.
Climate-Focused Credit Risk Assessments
Banks are working to embed climate risk into lending practices to reduce the potential for losses in the future. Some techniques in this effort include:
- Considering climate risk assessments at the origination of investments or loans. Businesses and even individuals seeking financing may need to demonstrate a plan for sustainability on top of traditional factors such as creditworthiness.
- Banks are using practices such as ESG scoring to include climate concerns in underwriting practices to mitigate risks further.
Sustainable Banking Stress Testing
Traditional risk forecasting does not work well in assessing climate risks because traditional models were never built with sustainability in mind. So instead, governments, central banks, and other institutions are implementing climate stress testing.
At its highest level, sustainable banking stress testing looks at whether an institution or process is taking the right actions and has a good mix of suitable investments to make it through the climate transition. However, stress testing should also occur at lower levels concerning each customer, investor, and investment.