The road towards sustainable lending
The European Commission early on stated that public initiatives alone were insufficient to achieve the EU’s sustainability goals. In 2018, the Commission published an action plan for Financing Sustainable Growth setting an EU strategy on sustainable finance and a roadmap for future actions across the financial system. One of the purposes being to reorient capital flows towards sustainable investments in order to achieve sustainable growth.
Now the time has come to focus on sustainable lending by implementing guidelines on loan origination and monitoring:
EBA guidelines on loan origination and monitoring
On 29 May 2020, EBA released guidelines on loan origination and monitoring. The guidelines highlight the importance of taking Environmental Social and Governance (ESG) factors into account in lending activities and states the following:
- ESG factors must be included in the institution’s credit risk strategy and credit risk appetite, and well documented in the internal government framework
- ESG factors should be included in the assessment of borrowers’ creditworthiness as well as the valuation of collateral
In order to comply with the guidelines credit institutions needs to ensure that internal governance documents, the credit approval process, early warnings, monitoring, data and IT-systems are updated from 30 June 2021. EBA guidelines on loan origination and monitoring thus signify a major step towards sustainable lending.
Time to expand the focus
FCG’s perception is that the main focus in many credit institutions is avoidance and divestment-oriented when it comes to ESG factors, thus that the institutions activities and processes focuses on avoiding harmful ESG activates. This is especially clear in the credit approval process where harmful ESG activities are minimized as a natural part of the credit risk mitigation. This approach is in line with the EBA GL on loan origination and monitoring which states that institutions should take risks associated with ESG factors into account in the credit granting process as well as in monitoring.
However, when reading other publications on the matter. For instance UN’s Sustainable Development Goal #9 and one of the principles in UNEP FI’s Principles for Responsible Banking as well as one of EBA’s latest discussion papers, it is clear that the regulators not only want institutions to reduce significant negative impacts on environment and society, but also that the institutions change lending policies and monitoring of portfolios in order to increase positive impact.
FCG believes the implementation on EBA GL on loan origination and monitoring is a vital opportunity for institutions to make important changes towards ESG positive lending by actively choose to support and promote positive activities.
ESG in practice
In order to successfully incorporate ESG factors to the credit-granting process and the monitoring of portfolios, it is vital to find a structured way to do so. In the credit-granting process a natural way would be to state that the institution does not grant credits to companies involved in area such as fossil energy sources, weapons or tobacco as well as promote ESG positive businesses in the internal governance documents, to align the credit-granting process and add relevant credit rules.
A plausible way could also be to use an ordinal model even though it could be challenging when the data lacks history, has quality issues and due to constant development.
However, when scanning the market, it is clear that this approach has been adopted by some investors to create incentives for asset managers to invest in more sustainable assets. The model scores sector and companies based on the carbon intensity of sales. Companies that emit the least in each sector are favoured. A similar approach could be used in the credit-granting process and in monitoring of credit portfolios in order for institutions to align with globally agreed ESG targets.
Together towards sustainable lending
FCG encourages credit institutions to seize the opportunity to make an important contribution in the journey towards a sustainable society. FCG would appreciate to support your institution, and offers assistance such as:
- Identify relevant ESG factors
- Specify ESG indicators and metrics
- Incorporate ESG factors in the internal governance framework
- Drafting as well as reviewing policies, instructions and guidelines
- Implement ESG factors in the credit-granting process
- ESG risk assessments and monitoring
- GAP-analysis on the institutions lending portfolio with globally agreed ESG targets
- Workshops/training for management body as well as operations