Exploring the future of environmental risk considerations in the banking sector

MSc (Environmental Management), North-West University, Potchefstroom Campus

Banks are exposed to environmental risks through their own operations, as well as through the activities of their clients. As financial intermediaries, banks are required to prudently manage the deposits placed in their care when issuing loans for projects and other transactions. Environmental risks form one of the many types of risks that need to be considered when banks make these financial decisions about which borrowers could get access to funding. The increased awareness of the environmental breakdown, climate change and other severe environmental related impacts, has raised expectations by broader stakeholders like activists and investors, that banks will use the funding mechanism to direct funding into more sustainable and “green” projects in an attempt to respond to the increased environmental risks created by environmental issues, such as climate change, air pollution, droughts, or loss of habitat. In this study the nature of environmental risk as it relates to banking is explored with the aim of understanding how banks will incorporate environmental risk considerations into their business models as a response to a perceived increase in environmental risk exposures. The research was conducted based on a literature review that aims to describe the current topical issues within environmental risk management that affect banks. As a business, banks face direct environmental risks, and are obliged to manage these risks within the legislative requirements, like all other companies. In addition, through their role as intermediaries, banks are required to make decision on the use of funding, and manage depositors’ funds prudently. This activity inadvertently exposes banks to indirect environmental risks. The literature review therefor covers both direct and indirect environmental risks. In addition to the literature review, a qualitative study was conducted to elicit views and opinions from banking practitioners on the future of environmental risk considerations in banking. The outcome of the research shows that environmental risk considerations are increasingly incorporated into banking, and have been for some time. There is an expectation amongst the respondents to this study that this trend towards increased environmental risk consideration within banking will continue, and that there is a growing understanding of how bank funding can either improve positive environmental outcomes. This expanding scope of environmental risk considerations within banking is also observed in the national, as well as global, climate change response that will see banks play an increased role in channelling funds towards environmentally sustainable business practices. Significant variation and ambiguity are observed in environmental risk management protocols within banking, leading to uncertainties about measuring and quantifying environmental risk and the banking industry regard it as a necessary and urgent progression towards more standardised methodologies for managing environmental risk. As other industries and companies are required to also adopt sustainable business practices, this will lead to a bigger burden on banks to incorporate more holistic environmental concerns into their lending decisions. The need for more consistency in quantifying environmental risk, as well as sustainability, is expected to result in the adoption of certain standards, both voluntary and regulatory, to enable this alignment amongst banks.

Masters