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

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