Banks play a major role in the American economy. They provide secure bank accounts and loans to 95% of Americans and large amounts of capital to businesses and nonprofit organizations. Each year, trillions of dollars flow through them to fund the growth of various industries, from agriculture to housing.
Yet despite their success, banks are not immune from the impacts of societal and climate change. Banks, like all businesses, are highly vulnerable to changes in customer demand. They’re also at risk of losing assets to extreme weather events.
To prepare themselves for these changes, banks have begun adopting sustainability principles in their operations, which include mechanisms that track climate risks and policies that promote community engagement.
Financial analysts predict that sustainability in the banking industry will make banks more aligned with the goals of the Paris Agreement and attentive to social equality issues in the communities they serve. In this article, we explore how sustainability will change the banking industry.
Key takeaways
Sustainability is important for banks because it helps them mitigate the impacts of climate change. Sustainable banks favor investments in renewable energies and socially responsible businesses over destructive businesses such as fossil fuel companies, helping them fund the future low-carbon economy.
By pledging their commitment to sustainability principles, banks align themselves with eco-conscious customers and investors.
A focus on sustainability will quite likely make the banking industry a key driver of low-carbon investments and community development projects.
What is the current state of the banking sector?
More than a year into the pandemic, the banking sector is still recovering from months of lockdowns in major markets. Business closures and limits on travel have dampened spending and investment activity. As millions of people have lost their jobs, several banks are dealing with severe credit losses and missed loan payments, which are expected to last until the end of 2021.
But it’s not just a dire economic situation that banks have to handle right now. Before the pandemic, technological changes had been shaking up the banking industry, which has now been accelerated by people’s inability to leave their homes. Fintech startups and neobanks with innovative online and mobile banking features now compete with major banks for customers. Customers, particularly Gen Z and Millennials, prefer digital banking services over visits to local branches.
Climate change has also been on the agenda of several banks. An Ernst & Young report found that in 2020, 52% of banks considered climate change as a key risk to their business within the next five years. Climate change developments, such as the wildfires in Australia and California, have created a sense of urgency that environmental disasters impact business growth and threaten assets.
Just in 2020 alone, natural disasters accounted for about $210 billion of damages around the world. The challenges brought about by climate change and the pandemic have led to increased calls for banks to take a greater role in addressing income inequality, gender inequity, and climate change in communities.
Why is sustainability becoming important for banks?
The ever-present risks from climate change make sustainability important for banks. Banks are the largest source of funding for corporations, from eco-friendly renewable energy companies to billion-dollar oil companies. Where banks decide to give their loans helps determine the direction of the economy, and to an extent, the future of our societies.
As a result, more and more shareholders, bank staff, and customers expect banks to embrace environmental, societal, and governance commitments to mitigate the impacts of climate change. A sustainability pledge shows that a bank is serious about preparing its operations for the future and contributing to a more equitable and sustainable society.
Setting sustainability commitments helps banks increase their credibility as key societal actors in an increasingly eco-conscious society. As more investors become concerned about climate risks, banks have little choice but to respond by investing in sustainability initiatives. A bank that’s seen as environmentally responsible and sustainable is likely to court more investors and get more business opportunities as it shows that it is adapting to climate risks.
In addition, sustainable principles help banks attract new banking customers and investors in their 20s and 30s who seek green banking products and services that help them support sustainable businesses, such as cashback on environmentally-friendly purchases. A commitment to sustainability also helps banks attract top talent that will become their next generation of management executives.
Since the signing of the Paris Agreement, climate concerns have precipitated a sentiment among government regulators and central banks that government regulations are crucial to preparing financial markets for climate change. Agencies such as the Commodities Futures Trading Commission have urged financial institutions to build mechanisms to measure and address climate risks.
How are banks integrating sustainability principles into their operations?
As the financial industry comes to terms with the risks that climate change poses to the global economy, several bank executives have begun building sustainability requirements into their investment frameworks.
The most profound action they’ve taken so far is to consider environmental factors before offering loans to companies. Banks have incorporated environmental due diligence into the lending process by requiring third-party reporting on loan proposals and assessments of a client’s environmental history.
Doing so creates a better chance that banks select eco-friendly companies to invest in that can provide good financial returns decades into the future.
Some banks have also taken leadership roles, working with regulators, clients, and trade organizations to advance sustainable finance agendas. Partnerships with these parties help banks address not just climate issues but also challenges in health care access, affordable housing, and education in the communities that they serve.
But perhaps the most visible sustainability initiative taken by banks so far is their long-term sustainable financing commitments. Some major banks have committed tens of billions to reforestation and environmental conservation projects as part of their pledge to make their operations more sustainable (though in the meantime, they continue to pour millions into financing oil projects).
Others have added to these financial commitments by pledging net zero emissions by 2050. Financial services institutions have said that they will curb carbon emissions from their operations and also from the companies they’ve financed.
Measures to achieve these targets include reducing loans to fossil fuel companies, investing in renewable energies, and using loan eligibility and rates to incentivize corporate clients to limit their reliance on fossil fuels and transition to sustainable business models.
How will sustainability change the banking sector?
Current trends in sustainable banking practices suggest that banks will become more attentive to climate change issues over the coming decades. The projected high costs of climate change could influence banks to invest in low-carbon technologies. Banks may also come under more government pressure to disclose their carbon emissions and serve economically distressed communities.
The banking sector may undergo a green banking revolution
Climate change poses several risks to banks. Crop failures may lead to loans not being repaid. Wildfires, with their ability to burn down entire suburbs, may cause extensive damage to assets. To prepare for these risks, the banking industry as a whole may initiate a green banking revolution to develop risk management mechanisms and put contingency plans for climate change in place.
Several banks have already begun conducting loan portfolio stress tests to assess the potential impact of the climate on their investments. And many more have started aligning their policies with the goals of the Paris Agreement to achieve climate neutrality by 2050. Banks may, as a result, become the key drivers of the global transition to a low-carbon economy.
If this transition is successful, banks could replace the fossil fuel industry with renewable energies. Banks might be more inclined to finance solar and wind energy projects as consumers demand more sustainable products and services.
Banks may become subject to more government regulation
The government may also become more involved in the banking industry to ensure that the economy succeeds in transitioning to a low-carbon economy. There are already signs that this is happening. Not long after coming into office, President Biden instructed financial agencies to include climate risks in economic policies and require financial institutions and corporations to disclose the climate change risks they face.
Increased government oversight may lead to a cultural shift within the banking industry. With more government pressure, U.S. banks may have little choice but to begin moving in a greener direction. They may start competing with one another to develop socially responsible mission statements and policies to win over customers and government approval.
In addition, more government regulation could give banks effective tools and guidelines to develop their own climate change mitigation and adaptation strategies. A concerted economic strategy to tackle climate change is likelier to involve all banks than letting them set their own climate goals.
The banking industry may become more involved in local communities
An increased focus on ESG criteria could see banks becoming more involved in the communities they serve. They may seek to champion diversity in the workplace and increase labor standards in their operations and supply chains. They may also publicly commit to being responsible employers who prioritize equality and fairness.
Industry analysts believe that this trend to become more socially responsible comes from banks’ desire to become industry leaders. Banks can no longer rely on profitability to demonstrate their importance to customers and investors.
Instead, banks have to build relationships with community members and commit to responsible lending activities, such as bank accounts and loans to low-income Americans, to show their commitment to sustainable development. Banks may also sponsor and fund community development projects and local nonprofits to foster economic growth in the areas they serve.
Other ways to bank sustainably
Keeping your money safe from funding fossil fuels should be a priority. With a sustainable online financial platform like Aspiration, you can rest assured that your deposits won’t be loaned out to fossil fuel companies.
Aspiration puts social and environmental responsibility at the heart of our business. Through our Spend and Save account, we help customers earn up to 3.00% APY while giving them opportunities to plant a tree with every transaction by rounding up their change through our “Plant Your Change” program. It’s our mission to help our customers build their wealth as they make the planet a better place.
Consider applying to Aspiration today!