What’s the true meaning of ESG for commercial lenders?
August 01, 2022
As the world makes faltering attempts to protect the natural environment, drive social equality and ensure corporate responsibility, environmental, social and governance (ESG) principles have emerged to help individuals and companies do the right thing.
However, with human nature as it is, we need laws to make principles stick. So, it’s only been a matter of time before regulations enter the game to turn ESG intentions into a hard and fast set of rules.
The compliance challenge
For commercial lenders, regulatory requirements for ESG are already taking shape, if not effect, around the world. Driven by regulatory bodies like the European Banking Authority, new guidelines highlight the importance of including ESG factors in your internal risk strategy and policies as well as in the calculation of customers’ creditworthiness.
Currently, lending regulation is putting most emphasis on the environmental side of ESG and asking firms to show they are greening their commercial portfolio and lending to more sustainable businesses. Soon, there will be hard targets to hit and more detailed data to report.
Understandably then, commercial lenders are now turning their attention to the most immediate challenge – compliance with short-term regulatory requirements.
But ESG principles deserve more than a short-term, tactical solution. The priority for lenders should be to drive new, more responsible ways of thinking and acting deep into the lending process.
That means embracing the sentiments of ESG and building the framework, the processes and the controls you need to make the right lending decisions every time based on all the right ESG data.
The process challenge
The key to embracing, not just reporting on, ESG is to embed its principles into your credit policy and your lending process. Throughout the lending life cycle, every deal – and how you price, score and service it – must take ESG into account, reflect your risk appetite and help you meet your internal as well as regulatory targets.
The question is how will you pull in the necessary ESG data? Although many banks have already developed an ESG rating methodology for large public companies, there’s not much data available to date on the unlisted private companies that make up a large percentage of many loan portfolios.
That leaves lenders with a lot of responsibility for intelligence gathering. And without the specialist knowledge or experience required, lenders may struggle to educate their customers on the implications of ESG for creditworthiness, prices and renewals. They could also slow down the lending process with potential weeks of manual work.
Therefore, as well as building ESG into your lending process as a whole, you need to keep that process as automated as possible. And that’s where technology comes in.
How technology can make ESG work for your business
Problems with data, reporting, risk models and risk ratings are all making it hard for lenders to come to grips with ESG. Technology can not only solve these challenges but also glue their management together into one cohesive, efficient process.
With a single end-to-end solution for commercial lending, you can define your ESG processes and bring them to life across the loan origination, credit assessment and ongoing monitoring stages of the lending life cycle while quickly identifying and integrating appropriate data to support human analysis.
Despite the complexities involved, technology also allows you to integrate ESG into the lending process without compromising efficiency. At the same time, the most advanced systems can actively help you balance compliance with profitability and consider the potential impact of deals on margins as well as sustainability.
Build a flexible framework for sustainable finance
However ESG rules and regulations develop, the journey toward sustainable finance is only just beginning. Lenders must therefore take a long-term view and look beyond compliance obligations to find the true meaning of ESG for their business.
The right technology will help you create a framework for managing ESG that embraces its principles, puts them at the heart of all your lending decisions – and makes them as integral to your loan process as the assessment of financials and KYC checks. It will also give you the flexibility to evolve your approach as regulatory requirements shift or grow.
Whatever your environmental, social and governance objectives, you can realize them loan by loan and meet profitability targets, too. But you need to make your lending process sustainable first.