Financial Services
Financial Institutions can Take the Lead in Social Impact
23 Feb 2023
Urgency is growing around the world to address social
challenges that have been exacerbated by the COVID-19 pandemic, civil unrest,
and the impending global economic downturn. The increased recognition of the
interconnectedness of social and environmental issues highlights the importance
of addressing both in tandem. Climate change poses a significant threat to
global economy
Given their crucial societal role as fiduciary stewards,
large-scale employers, allocators and distributors of capital, financial
institutions possess a unique capacity to significantly impact a wide range of
social issues. By addressing these issues, financial institutions can access
new markets, achieve better financial performance and reduced cost of capital,
attract top talent, and mitigate reputational and regulatory risk.
Although a few innovative institutions are taking the lead,
most banks today take a narrow view of the opportunity to address social
issues. Typically, they concentrate on the "S" topics contained in
existing ESG rating frameworks, such as enhancing diversity, equity, and
inclusion (DEI) in leadership and recruitment, creating culturally relevant
marketing strategies, or safeguarding consumer data.
These issues are undoubtedly important, but we believe that
banks can embrace a more holistic approach to their social impact and redefine
their role in society. Achieving this goal requires banks to examine how they
shape the world across all lines of business, including retail and small
business lending, capital allocation decisions, and the societal influence of
their corporate investments and borrowers.
Integrating Social Responsibility into Core Business
Presents a Compelling Business Case for Banks
Banks that take a lead on social issues can achieve more
than just altruistic goals, as it has the potential to create value in several
ways when executed effectively.
By leveraging social and sustainable practices, banks can
gain access to expanding markets, either by tapping into new markets or
expanding their share in existing ones across various business segments.
For instance, the market for global social and sustainably
linked bonds has grown threefold since 2019, exceeding $1 trillion in 2021,
providing a lucrative opportunity for corporate and investment banks.
Furthermore, by increasing lending to credit-worthy small businesses led by
women and minorities, banks can also tap into a rapidly expanding segment of
the market.
Fostering a strong social presence can also aid
in attracting and retaining talented employees for banks. For instance, over
75% of job seekers and employees consider a diverse workforce to be a crucial
factor when evaluating job opportunities and companies. Additionally, younger
employees, who are a crucial talent pool for the future, tend to place even
more emphasis on diversity, equity, and inclusion (DEI) in the workplace.
Underperforming on Social Impact Creates a Real Risk for
Banks
The expanding social regulatory and reporting requirements
that banks face could result in fines or other penalties if they fail to
comply. Social regulations are not a recent development in the financial
industry. For instance, in the United States, the Community Reinvestment Act
(CRA) mandates banks to report on their approach to meeting the credit and
banking service requirements of the entire market, including low- and moderate-income
communities. Similarly, banks in India are required to provide discounted rates
for financing micro, small, and medium enterprises.
Furthermore, although such regulations are firmly
established in various regions across the globe, the bar for regulatory and
reporting requirements is expected to increase even more in the upcoming years.
Even though these initiatives are still evolving, it is evident that banks will
be held increasingly responsible for the actions of the entities they finance.
Even in the absence of elevated regulatory scrutiny, the
reputation of banks can suffer if their clients are associated with
questionable activities. Banks have, in the past, faced negative impacts on
their reputation due to activities such as discriminatory practices, overly
aggressive mortgage lending, and questionable retail marketing tactics.
However, in recent times, financial institutions
are increasingly being held accountable for the actions of their clients. For
instance, BankTrack, a support organization for civil society, assesses banks
based on the UN's Guiding Principles on Business and Human Rights, highlighting
instances where bank business activities are related to human rights violations
Types of Social Impact Investments for Banks
Community Development Financial Institutions-
Community Development Financial Institutions (CDFIs) are a
type of social impact investment that banks can make to support under-resourced
communities. CDFIs are specialized financial institutions that provide affordable
lending to low-income and underserved individuals and small businesses.
CDFIs
serve as a vital source of funding for small businesses and community
development projects in low-income areas. Banks can invest in CDFIs as a way to
support economic development and address inequality. The investment can take
the form of equity, debt, or deposits. Banks can also partner with CDFIs to
provide technical assistance and support to small businesses in their
communities.
Green
Financing- Green financing is a type of social impact investment that
focuses on supporting environmentally sustainable projects. In recent years,
there has been a growing recognition of the need to address climate change and
other environmental issues, and many banks are responding by offering financing
for green projects.
In
India, there is an urgent need to increase the flow of finance to green energy
projects in order to meet the country's environmental targets. According to the
Climate Policy Initiative, India needs INR 160 trillion to meet its 5-year
targets to reach net zero emissions, known as Nationally Determined
Contributors (NDCs), by 2030. Additionally, India needs INR 720 trillion to
achieve net zero emissions by 2070, as per the Paris Agreement.
By
investing in green financing, banks can support the transition to a more
sustainable economy while also generating attractive returns for their
shareholders. Green financing is a rapidly growing market, and there is
increasing demand for investments that support environmental sustainability.
In
addition to the potential financial returns, green financing can also help
banks meet their own sustainability targets and demonstrate their commitment to
environmental responsibility. This can improve their reputation and help
attract socially responsible investors and customers
A
Holistic View on Social Impact
- Banks
must adopt a holistic and systematic approach to their strategies for social
issues due to the significant benefits and potential risks involved. Current
practices in most financial institutions for addressing social issues are
haphazard and uncoordinated. Thus, there is an urgent need to bring
organization and rigor to their efforts.
Addressing social issues is
complicated and distinct from climate action. Unlike climate change, where the focus
is primarily on greenhouse gas emissions, there are numerous social topics that
banks must take into account for themselves, their clients, and the companies
they invest in. Moreover, the definitions and standards of social issues and
the optimal combination of actions required to address them vary across
different countries
Banks
can begin by evaluating their opportunities to create social impact across
three distinct areas
- Through Direct Operations: This sphere includes the bank's
own operations, such as employee diversity and inclusion, responsible
investment practices, and community outreach programs.
- Through Value Chain: This sphere covers the bank's clients,
partners and vendors, including assessing the social impact of products and
services, supply chain practices, and engagement with stakeholders.
- Through Societal Contribution: This sphere
encompasses a bank's broader societal impact, such as charitable giving,
public-private partnerships, and contributions to sustainable development
By
using this framework, banks can prioritize their efforts, set clear goals and
targets, and measure their progress towards creating a positive social impact.
Ultimately, adopting a comprehensive approach to addressing social issues can
help banks manage risks, improve their brand reputation, and create long-term
value for all stakeholders
Author: Shishir Mankad, Managing Partner, Praxis Global Alliance