Guest Article: An ESG Perspective on the Finance Industry

Guest writer and CSR expert Jaimini Luharia explains how financial institutions such as banks are responding to ESG trends and promoting sustainable finance - and meeting new requirements such as materiality assessments.

How Banks are Incorporating ESG

Environmental, Social, and Governance (ESG) factors have gained increasing significance in the banking sector as stakeholders demand more transparency and sustainable business practices. The BFSI (Banking, Financial Services, and Insurance) sector plays a pivotal role in addressing environmental and social challenges by influencing industries and economies through financing, lending, and investment activities. The sector’s alignment with key Sustainable Development Goals (SDGs) includes SDG 8.10 (universal access to banking and financial services), SDG 2 (sustainable agriculture), SDG 7 (renewable energy support), SDG 4 (educational financing), which enables it to support and promote sustainable development across various dimensions.

Sustainable Finance: A Growth Story

Globally, financial institutions are increasingly aligning with key initiatives to accelerate sustainable finance, driving significant progress toward achieving global climate and sustainability goals. These initiatives are crucial in fostering greater ESG (Environmental, Social, and Governance) integration across portfolios and investment strategies. The Net Zero Banking Alliance (NZBA), a key driver to Principles of Responsible Banking (PRB) and Glasgow Financial Alliance for Net Zero, ensures net zero emissions across various portfolios, committed by its members. In addition, various initiatives like the Climate Bonds Initiative, Global Impact Investing Network (GIIN), and Principles of Responsible Investing (PRI) continue to promote sustainable financing globally.  In India, SEBI’s mandate for Business Responsibility and Sustainability Reporting (BRSR) and frameworks like ‘Framework for Green Deposits’ by the regulatory body Reserve Bank of India (RBI), are instrumental in driving financial institutions to integrate ESG frameworks in their businesses.

The Role of Banks

Banks are at the center of global economic activities, influencing industries through their lending, investment, and financing decisions. As a result, the ESG risks and opportunities they face are multi-dimensional. A materiality assessment is one of the essential tools that banks use to identify which ESG factors are most relevant to their operations. This process helps banks prioritize key ESG issues that have the most significant financial, operational, and reputational impact on their business while addressing stakeholder concerns.

Materiality Assessments: Single vs Double

A single materiality assessment in the banking sector focuses on identifying and evaluating ESG (Environmental, Social, and Governance) issues that have a direct financial impact on the bank. The primary goal is to assess how various sustainability-related risks and opportunities affect the bank’s financial performance, profitability, and long-term value. This contrasts with double materiality, where both the financial impact on the bank and the external impact of the bank’s activities on society and the environment are considered. Some examples highlighting single materiality issues are: How exposure to industries vulnerable to climate change (e.g., fossil fuels, heavy manufacturing) could affect loan performance or asset values, new regulations or disclosure requirements related to ESG that might impose costs or operational burdens on the bank, and reputational risk on the Bank in case it is found to involved in unethical lending practices. All these issues directly affect the Bank’s performance.

Materiality Assessment example topics

Financial institutions can effectively capture and address risks and impacts by refining their double materiality assessments through a multi-faceted approach. Double materiality considers both financial materiality (how sustainability issues affect the business) and impact materiality (how the business affects society and the environment). Some of the examples that highlight double materiality assessment for financial institutes are: Financing fossil fuel extraction projects, the bank is indirectly contributing to the displacement of communities affected by rising sea levels, extreme weather events, or environmental degradation caused by fossil fuel-related pollution, and, if the bank continues to fund coal projects while competitors pivot to green financing, it could lose business from climate-conscious customers and investors. From a financial materiality perspective, the bank must evaluate the risk of continued exposure to fossil fuel industries, which may lead to loan defaults, asset devaluation, and loss of investor trust due to reputational damage. From an impact materiality perspective, the bank must assess its role in contributing to climate change and the negative social and environmental effects of financing carbon-intensive projects. Stakeholders (such as NGOs, customers, and regulators) are increasingly demanding that banks reduce their involvement in activities that harm the environment and contribute to climate-related risks.

Recommendations for Financial Institutions

The following recommendations provide a pathway for financial institutions to strengthen their ESG strategies, risk management, and stakeholder engagement:

Build Internal Capacity and Awareness

• Cross-Departmental Knowledge Sharing: ESG risks and impacts often involve specialized knowledge from various departments, such as human rights, environmental, social, and business risk teams. However, risk teams may lack experience in considering the broader impacts on people and the planet.

• Training and Education: Conduct training sessions to build internal capacity and establish a shared understanding of double materiality. This ensures all teams understand both the financial risks to the business and the external impacts on stakeholders.

• Unified Strategy Development: Develop a common framework that aligns environmental, social, and governance teams with business risk teams. This facilitates consistent assessment and reporting.

Align with Impact Materiality Assessment Criteria

• Move Beyond Perception-Based Approaches: Traditionally, materiality assessments may have relied on stakeholder perception or surveys. Instead, focus on assessing the real-world impacts of business activities on human rights, the environment, and society.

• Impact Likelihood and Severity: Incorporate frameworks like the UN Guiding Principles on Business and Human Rights (UNGPs) to evaluate how likely and severe these impacts are, ensuring that the focus is on substantive issues rather than perceived reputational risks.

• UNGPs Alignment: Ensure that the process adheres to the expectations outlined in the UNGPs, which emphasizes assessing risks to people and planet, not just risks to the business itself.

Ensure Effective Stakeholder Engagement

• Engage Diverse Stakeholders: While traditional stakeholder engagement may focus on investors and close business partners, it is crucial to include the right stakeholders (such as affected communities, civil society groups, and trade unions). These voices provide critical insights into potential and actual outward impacts.

• Inclusive Consultation: Prioritize consultation with those directly or potentially affected by the institution's operations. This involves gaining insights into both inward (business risks) and outward (social and environmental) risks that may not be evident from conventional stakeholder engagement.

  
  

Valuate issues and Performance Against Global Standards

• Align with International Standards: When assessing materiality, use well-recognized global standards like the Universal Declaration of Human Rights, the ILO Core Conventions, and the Paris Climate Accord to guide the identification of key issues.

• Process-Based Frameworks for Responsible Business Conduct: Rely on frameworks such as the UNGPs and the OECD Guidelines to inform the process for managing and mitigating ESG-related impacts. These frameworks help institutions develop clear action plans and provide accountability mechanisms to address identified risks and impacts.

By integrating these recommendations, financial institutions can strengthen their capacity to address both financial and non-financial risks. This holistic approach ensures that organizations not only protect their long-term profitability but also act responsibly toward their wider social and environmental stakeholders.

Conclusion

The financial industry is at the forefront of driving sustainable development through ESG integration. By financing green projects, promoting financial inclusion, and adopting strong governance practices, financial institutions have a powerful opportunity to contribute to a more sustainable, equitable, and resilient future. However, addressing the challenges related to data transparency, greenwashing, and balancing short-term profits with long-term goals will be critical to fully realizing the potential of ESG in the financial sector.

Jaimini Luharia is a CSR professional with more than 8 years of experience working with corporations, UN agencies, non-profit organizations, and consulting firms. She is certified in Impact Investment, UNIDO (United Nations Industrial Development Organization), Environment and Social Framework by the International Finance Corporation, World Bank, and Introduction to ESG by Corporate Finance Institute.