Sustainable finance – the integral role of banking
European banks finance two-thirds of the European economy, a much larger proportion than anywhere else in the world. It goes without saying, therefore, that the banking sector will play a critical role in the mission to build a more sustainable future.
The good news is that banks and indeed regulators are on board, with a flurry of announcements, bold statements of intent and new policies over the past weeks and months. The latest EY/Institute of International Finance (IIF) risk survey shows banks increasingly recognize the importance of this topic, with 52% of respondents viewing environmental and climate change matters as a key emerging risk over the next five years, up from just over a third (37%) a year ago.
Banks are now moving beyond words to actions. We have high profile examples of banks setting out their intention to use their financial weight to help customers as they transition to more sustainable business models and meet key climate change targets.
Some of this comes from a regulatory push of course – be that environmental stress tests or consultations on how banks manage climate-related and environmental risks. But it goes way beyond the risk domain. Embracing sustainable finance is the new frontier of growth. Early movers stand to gain financially and reputationally (a rare combination in my experience).
One positive example of the power of banking is the growth in green finance. Corporate lending tied to a sustainability metric – such as reducing emissions or waste – increased by 800% in 2018 to US$36.4b. In response to the growing investor demand for sustainable options, the green bond market, which emerged in 2007, also grew to a global total of US$521b. Demand for green banking products is expected to increase rapidly in the coming years, particularly as younger people become more active banking customers and investors, with the latest EY Megatrends report finding climate change topped their list of most important global challenges (pdf).
Another positive trend has been increasing transparency. In 2019, the United Nations introduced its Principles for Responsible Banking, which include commitments by banks to contribute to climate change mitigation and adaptation. It’s an issue we feel strongly about at EY, which is why we were the first professional services organization to sign up. After a year, the number of signatories has grown to nearly 200, representing around 40% of the banking industry and serving more than 1.6 billion people worldwide.
It’s still early days and there’s a huge amount of work for banks to do in order to deliver on recent bold statements. Many of the commitments are long term so will require resilience and consistency of leadership through multiple CEO successions. There will be no shortage of stakeholder scrutiny along the way and rightly so. And yet, the fact that the sector is being so bold and vocal is very much a cause for optimism.
Truly embracing technology
COVID-19 has accelerated and emboldened banking transformation plans. In the last few months I have seen a step change in ambition, more radical visions of what a bank could and should look like and a more intense drumbeat of change. Digitization plans that were slated to evolve over a number of years are now being fast-tracked, as banks recognize that ways of working and interacting have probably changed irreversibly. There is an industry obsession with data (banks have no shortage of data) – how to protect it and use it responsibly; how to derive value from it; how to use it to improve customer experience.
There is also renewed focus on automation, on breaking the constraints of legacy systems through cloud and on exploring a variety of platform banking models.
Technology holds the key to the next wave of banking transformation but turning this into reality requires investment funds and an openness to collaborate and form ecosystems with third party providers and FinTechs. The scale of the transformation required means no one can go it alone. We are seeing an acceleration and a broadening of bank/fintech collaborations in digital payments platforms linking merchants and consumers, financial crime management and regulation to name but a few hot areas.
The pandemic has provided the clarity required to show banks that they need to invest more in their digital offerings. The risk for the banks is that their smaller, more nimbler competitors are already doing it.
The second half of 2020 is when a lot of detailed design work will be completed and finishing touches applied to some of the bold plans I’ve mentioned above. 2021 will be when the rubber really hits the road, with the hope that a rebound in profits next year can help sustain the funding needed to complete the job.
Last (positive) thought
I genuinely believe that banking in the next few years will move at a speed we haven’t seen for a generation. The areas I have mentioned have the power to be transformative and restorative for banks and their multiple stakeholders.
The stakes are high. European banks have had low returns on equity for some time and need to reframe their future. Europe needs a strong banking sector like never before to help us navigate the stormy waters that lie ahead. I hope reading this, you agree with me that banking is stepping up to meet the challenge.
