Rethinking Sustainable Banking

By December 18, 2017Finance

The US stands at an impasse right now and is not progressing fast enough on its Sustainable Development Goals (SDGs). There have been many policy setbacks that have removed the few public incentives necessary for companies to develop strategies around the SDGs. However, one of the larger issues companies face is financing, and where the public sector is failing, the private sector can help. Specifically, I’m referring to the concept of sustainable banking.

Right now, the necessary innovation that needs to happen to meet the sustainable development goals is not gaining traction fast enough. Many companies in the US are engaged in a cycle of short-term thinking that is little more than speculation and performance manipulation in the form of stock buy backs. Just in the last ten years, companies have spent more than $3 trillion on stock buy backs. David Kostin projected that in 2017 alone, Fortune 500 companies would spend $780 billion on buybacks. When a company buys back a stock, it allows a company to inflate their share price and gain bonuses from perceived performance gains. Win-win right? Well, not so much. You see, the money being spent year after year on buybacks could have been directed towards investment into new plants, R&D, property, and equipment. The primary growth areas of the real economy, which require long-term investment for positive scaled outcomes, are being ignored in favor of short-term returns. Thankfully, there are new forms of commercial banks that can play a critical role in turning the tide: sustainable banks.

Sustainable Banking: A New Hope

Sustainable banks are normally commercial or development banks that have a few particular characteristics. Sustainable banks profile based on sustainability, they are real economy focused, and at times, they are community needs focused. Sustainable banking institutions (SBI) have demonstrated over the last 12 years to have more stability in liquidity risk than traditional banks and have a steady return on assets and return on equity, whereas traditional banks have much more variability in all aspects and tend to be slow to reach former returns after taking a hit during an economic downturn. Additionally, due to SBIs investing in the real economy, the social and environmental impact is far easier to measure and account for. With traditional banking, impact is often an abstraction non-existent for communities on the ground. SBIs, on the other hand, have the benefit of the community understanding where the money is flowing and how it is contributing to their quality of life.

Let’s explore what those mean and how they define a sustainable bank’s operations.

Sustainability Profiling

SBIs add an additional layer of scrutiny to investment decisions relative to their mission. Some SBIs are focused on their immediate community and social impact, while others are focused on the environment or both. This added layer of scrutiny often is a defining feature of SBIs, where their values are included in the vetting process. Some banks have claimed to use pre-existing sustainable frameworks to evaluate the sustainability of a company, the most popular being the B-Corp assessment.

Real Economy Focus

Many SBIs focus on investments in the real economy, that is, capital equipment or just the part of the economy that actually produces goods and services. Speculation in the financial markets do not seem to be promoted as a positive feature of an SBI unlike a traditional bank. According to the research from the Global Alliance for Banking on Values (GABV), the focus that SBIs have on deposit taking generates a lower liquidity risk and makes capital more suited for real sustainable development. The speculation on the market that is done by traditional banks is rent-seeking and a waste of resources from a social impact lens.

Community Needs Focused

Many of the banks that are part of the GABV have a baseline scope limited to their immediate community or, at most, region. Examples include Bank of Palestine, Banco Ademi, and Alternative Bank Switzerland, among others. What all of these have in common is that they have all become some form of a development bank that focuses on regional needs or critical community needs and seek to provide the underutilized capital to meet that need.

There’s a Catch Though

While sustainable banking may sound excellent for the most part, there are some significant drawbacks that undermine their mission. First is the national regulatory environment in the United States. SBIs are at a significant disadvantage as a result of a regulatory structure that encourages and upholds the traditional banking practice. This, of course, is in the United States, MENA, Europe, and some Latin American countries. However, sustainable banking might be a near-perfect match in places leading capital market structural orientation towards sustainability like China. The West is still focused solely on financial return, and the capital market structures and regulatory environment reflect this concern in their shape.

The other drawback or flaw of sustainable banking is for the most part self-made, that drawback being sustainability profiling. SBIs current profiling practices are primarily screenings at the time of making a commercial loan. The flaw here is that many SBIs are using tools that are static and used as a filter for one part of an extended traditional process. One of the most notable SBIs is the New Resource Bank (NRB), who openly states that their assessment tool is the B-Corp Assessment. The B-Corp tool has been critiqued for not being accurate to material realities, and the score is often considered little more than a marketing tool. The assessment is largely self-reported and not verified by third parties in the various categories that B-Corp covers. Of the weaknesses that one could talk about in an SBI, the main assessment tool for profiling and deciding investment decisions is not tied to reality beyond self-reporting. This leads to business to business conversations with both being able to say they had impact but neither having ever engaged the community.

Linking Sustainable Banking and SDGs

While the B-Corp assessment may be a measure of a company’s commitment to sustainability, SBIs should orient their screening more towards metrics and performance indicators that are linked to SDGs. Such measures would tie operations to not just the local economy but also to the global effort of meeting goals for civilization’s progress. Linking sustainable banking to the SDGs would also help connect companies to resources and other peers across the globe that  they may have otherwise never contacted.

Stay tuned as we will publish more articles expanding on the ways in which sustainable banks can best integrate SDGs into their profiling practices and organize operations around SDGs.

Joshua Morales

Author Joshua Morales

Joshua Morales is a U.S. based sustainability expert and President at Isla Innovations. He enjoys writing about policy developments, technology, and economics. You can find him on Twitter at @SDG_Joshua.

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