THE return of higher interest rates results in a greater short-term profitability for many financial institutions. But it suggests that for all but a select few players with lucrative specialties, the gains do not last. So, what would be the next thing that should be looked into and take care of?
It is believed that institutions of all sizes should regard the next couple of years as a respite, a brief window of opportunity, to rethink their business plans. The key to that revamp is finding their place in a sustainable finance, green lending and investment activities. The banking industry lacks a future-proof business model and the growth premium that is seen in other industries. It is high time they changed the existing model.
It is expected that sustainable financing to move beyond the short-term trendy activities sugar-coated by some as ‘green-washing’ to a new phase will push needs for such banking deeper into ordinary people’s everyday lives.
Globally, sustainable bonds account for about 11 per cent of the total bond market volume and sustainability-related syndicated loans about 13 per cent of the global syndicated loans market. Only a small percentage of banks have near-term capabilities to finance some of the most dynamic burgeoning areas, including grid-scale infrastructure, green hydrogen, green fuels, biomass, carbon capture and storage.
It is, however, predicted that lenders to small businesses and consumers would see opportunities for business growth as both the groups move on their own or under government pressure towards green alternatives for facilities, transportats and housing. In addition, the need for additional forms of sustainable lending will, thus, expand.
Why banks should strategise now: It has a few years to shape the future in ways it could not have been in the past few years. There will be a temptation to fine-tune things while the sun shines, but the hard work of re-invention is essential and urgent. Smaller institutions enjoy a greater potential agility to make such changes than major institutions, which take longer to shift. Financial institutions must take on more responsibility for facilitating access to solar panels and batteries required for reconstruction. This is an indication of how quickly small banks could make the shift to a more green-financing activity.
The message is not that sustainable financing only serves large banks. It would, rather, mean that the shift towards a low-carbon economy affects businesses of all sizes and households everywhere. Financing the energy transition will require a massive reallocation of capital. Banks are on the front line to provide financing and advisory support for a wide range of opportunities.
Retail banking and potential opportunities: The availability of charging stations is far from uniform and that may create financing opportunities both among commercial establishments that want to add fast-charging capabilities for customers as well as house-owners who want fast-charging at home.
‘Green mortgages’ are loans to finance the purchase of energy-efficient houses or to pay for energy-efficient home improvements. These often carry a low rate as an incentive to encourage energy-efficient housing. Frequently, this relies on a state or local subsidy of the discount. The adoption of such mortgages has been somewhat limited. Both banks and specialised lenders have already been financing solar energy installations. There is a potential ‘green-embedded finance’ opportunity as part of electric-vehicle digital platforms that provide consumers with one-stop electric-vehicle education, purchasing and financing options. The general idea is that deposits are not funding such activities as fossil fuel exploration and production. ‘Eco-friendly’ banks and other financial firms can offer such saving and investment opportunities.
Small business banking and potential opportunities: It is still early on this front. It may be said that sustainability among mid-size and small businesses would create openings for financial services players. Growth for banks serving such markets would be rooted in scalable financing solutions for commercially viable products and services and in providing expertise and capabilities. Among the potential opportunities will be lending for companies that retrofit their facilities for energy efficiency. This includes financing energy-efficient equipment as well. Businesses that rely on transports to deliver their services or products represent another financing possibility through bank-provided fleet finance.
Green loans: Whatever a banker’s personal feelings may be about the rise of ESG issues, environmental, social and governance data highlight the importance to a growing percentage of consumers. It finds that 83 per cent of consumers worldwide think companies should be developing an ESG best-practice strategy. The problem, however, is that environmental, social and governance data put many financial institutions in a tough spot. It is a new term. There are a few regulatory standards and it is unclear what it takes to meet society’s ESG expectations.
Soon, too, publicly-traded banks could have a different set of standards than privately held financial institutions to announce its climate-risk disclosure rules, following a comment period that ends each year. There seems to be hot water on all sides in acting or not acting. That said being said, there are some steps that financial institutions can take that can help them to stay ahead on the ESG curve. Green loans not only appeal to consumers and investors interested in connecting to a sustainable brand, they also provide a bank with wholly new revenue streams. The banks that put sustainable lending on a bold sustainability agenda will be best positioned to thrive in a world where the public, shareholders and regulators expect them to do the right things. If bank teams wonder where and how to begin with ESG strategies, they are not the only one. Green loans can be a good place to start with.
Risks of taking ESG action and way out: It is important to recognise that there are risks every where in banking; and, ESG action is not an exception. The case in point is that there is contention-building in banking over modifying existing lending strategies. It shows that these banks clearly understand the issues and talk but do not walk the walk. It is purely public relation and not actions.
Yet, there is another side to the coin especially if financial institutions fail to take any action. Large investors have, in some cases, dropped companies that do not disclose their emission. But, it does not have to be. Adopting sustainable lending practices and making green loans can be a good place to start with. Green loans can come before overhauling old lending format, adopting comprehensive ESG strategies, hiring staff to handle impending regulations and drafting full ESG reports. Banks should accept that they have an inherent responsibility to maximise impact for good. They should not take lightly the mantra of changing finance to finance changes. There are ESG options that banks can try as well.
A few are green mortgages: homeowners receive discounted mortgage rate if the houses meet predetermined energy standards; green loans: loans facilitated for consumers and businesses looking for renewable energy, green building or sustainable farming financing; sustainability-linked supply chain finance: suppliers of local retailers can get preferential financing rates if they meet sustainable targets such as carbon footprint data or emission mitigation; and green loans securitisation: asset-backed securities ‘with proceeds raised to finance loans for green infrastructure.’
The new market has grown over the year. It is only expected to continue. Many banks in the space are concerned about the ‘bankability of some of the organisations and projects in the sustainable lending category’. The opportunities can, however, outweigh risks especially if financial institution leaders take time to approach green-lending correctly.
ESG strategy is not always about offering brand new products. Banks can also embed incentives such as mortgages in current loan products to encourage customers to lower their carbon footprint. Financial institution leaders can overcome this by incorporating modular training or offering certification programmes for employees to learn more of delivering green loans and what to look for.
Md Kafi Khan is company secretary of the City Bank Limited.
