The marriage between banks and sustainable practices

Banks may adopt sustainability practices, policies, and metrics for different reasons. Some will do it out of conviction, others out of convenience or compliance. In any case, it is undeniable that the relationship between banks and sustainability is becoming a fundamental aspect of the financial market.

There are at least three points of interaction between banks and the sustainable economy. Firstly, banks must themselves be examples of sustainability. This means reducing their environmental footprint, optimizing the consumption of natural resources, promoting diversity and inclusion among their staff and adopting more transparent and responsible corporate governance practices. Internal sustainability is not only a social and environmental responsibility but also a competitive factor. The adoption of these practices must balance international standards with customized options for each institution, aligning them with previously established goals.

Secondly, banks must integrate an ESG risk analysis into their credit decisions. ESG risk analysis consists of assessing how environmental, social, and corporate governance factors can affect a company's financial performance and financing. For banks, this analysis is crucial for identifying and mitigating the risks associated with their clients and portfolios, as well as identifying new business opportunities. This process is complex and must be guided by quantitative rigor and regulatory mechanisms.

Finally, banks can adopt financial products with a significant emphasis on sustainability. Banks can act as agents of change, directing capital flows towards activities that promote sustainable development and help mitigate climate risks. In recent years, a number of sustainable financial products have been launched, such as sustainable credit lines, sustainable bonds(such as green bonds), sustainability-linked bonds  (SLBs) and sustainability-linked loans (SLLs). These products have become relatively common in the banking and corporate market in Portugal. Examples include EDP's green bonds and the sustainability-linked bonds of Navigator and Mota-Engil, among others.

These products follow universal standards, such as the ICMA Green Bond Principles, ICMA Social Bond Principles, ICMA Sustainability Bond Guidelines, EU Green Bond Standard, LMA Green Loan Principles, LMA Social Loan Principles, ICMA Sustainability-Linked Bond Principles, LMA Sustainability-Linked Loan Principles or LSTA Sustainability-Linked Loan Principles.

These products also presuppose the adoption of a Sustainable Finance Framework (also known as a Green Finance Framework or similar designation) and the intervention of Second Party Opinion providers, which are independent assessments carried out by rating agencies, non-financial rating agencies or specialized consultants, such as Sustainalytics, ISS, CICERO, among others.

What are the advantages of these products for banks? Each institution will make its own internal assessment, but in general, as well as strengthening their reputation in the market and responding to growing customer demand, banks also benefit from ensuring that their corporate clients adopt sustainable practices, which reduces their exposure to risk and the likelihood of default. In addition, these financial mechanisms, depending on certain factors, can contribute to the bank's Green Asset Ratio (GAR), a mathematical formula that evaluates the weight of 'green' loans in the total loan portfolio.

The integration of sustainability practices by banks cannot just be a matter of compliance or marketing. By taking the lead in sustainability, banks not only strengthen their market position and respond to growing customer demand, but also contribute significantly to mitigating environmental and social risks. This commitment, in addition to enhancing their reputation, can unlock new business opportunities and promote a more sustainable and responsible financial market. The marriage of banking and sustainability is not a passing trend, but a fundamental transformation that will shape the future of the financial sector.