Banking on Responsibility

Global Finance, Sep 2005 by Green, Paula L

Increasingly, banks are discovering that strict lending policies can be a powerful risk management tool.

Whether they are pulling together a complicated financing package for a hydropower dam half way around the planet or lending to a local chemical company down the street, banks are increasingly looking at the impact of their lending practices on the environment.

And it is not only the uncomfortable public scrutiny created by global activists protesting outside an unwanted logging mill in Indonesia or bank headquarters in downtown San Francisco that has more and more banks scrambling to create an environmental policy around their loans. Banks must increasingly worry about how the environmental activities of their corporate clients can affect their own credit risk.

"Banks are paying more attention to corporate social responsibility because they realize it's good business...it can affect their bottom line and their financial statements," says Sang Hwang, an analyst with SNL Finance in Charlottesville, Virginia.

Today, banks not only face the specter of an expanding portfolio of non-performing loans if their lending officers do business with environmentally careless companies that go belly up because of pollution clean-up costs; tougher environmental regulations also mean a financial institution could even be held responsible for the clean-up costs of a polluted site if the land owner or business owner is unable to ante up.

"Legislation can play a very important role in helping industry and banks move toward less polluting projects," adds Hwang, who also holds a doctorate degree in environmental design and planning from Virginia Polytechnic Institute and State University in Blacksburg, Virginia. "The smart companies and the banks are aware of these situations. Paying attention to the environment makes good business sense, both from providing business opportunities and satisfying shareholders' perception that corporations should be good stewards of the environment."

Ilyse Hogue, global finance campaign director for the Rainforest Action Network in San Francisco, agrees that the greater attention emanating from bank customers and other stakeholders, as well as the costs associated with financing environmentally sensitive projects, are putting pressure on bank managers.

"If there is resistance to a project and concerns about its environmental impact, that can play out economically," says Hogue, pointing to the huge cost overruns associated with controversial projects, such as the Royal Dutch Shell Sakhalin project. In July the giant energy company announced that the costs of its Sakhalin II project, which aims to tap into 4 billion barrels of hydrocarbons off the eastern coast of Russia, had doubled to $20 billion.

Hogue says the increased economic and public pressure is in turn gradually shifting the mindset of bank executives. "When they are forced to look more closely at the consequences of their lending decisions, they are inevitably examining the mark they are going to leave on the world," she says. "In many cases, irresponsible lending can lead to environmental destruction and human injustice. No one wants to be responsible for that."

"It's a slow process, but there's been a real sea change in the industry and a real shift in thinking," Hogue adds, "but with that said, there's still a long way to go."

One of the most prominent displays of the global banking community's greater attention to the environment is the Equator Principles. A voluntary set of guidelines for managing the environmental and social risks associated with financing large development projects like dams and oil pipelines, the Equator Principles were first adopted by 10 banks in June 2003. Today, more than 30 banks around the globe have signed on to the principles, which are modeled on the policies of the World Bank and the International Finance Corporation (IFC), the World Bank's private sector investment arm.

The principles use a set of specific mechanisms to help banks ensure that a development project they are financing won't damage the environment excessively or disrupt the local community, such as by displacing indigenous people. The guidelines are voluntary and apply to projects with a total capital cost of $50 million or more. Jon Sohn, a senior associate at the World Resources Institute (WRI) in Washington, DC, agrees that the Equator Principles are a good example of how the banking community is paying more attention to social and environmental concerns. But the next step is for financial institutions to develop techniques and tools to implement these principles and make the techniques transparent to stakeholders, he says. "There's three categories [of banks that have signed on to the Equator Principles]: banks that have taken this to heart, like Citigroup; banks that are adopting and working through the implementation, like JPMorgan Chase; and the free riders," says Sohn, adding that unfortunately many of the signatories fall into the third category.