Welcome to our ESG deep dive, a series of articles highlighting the critical impacts of major business sectors on people and the environment.
The banking sector plays a critical role in securing a healthy future and has the potential to be a powerful force for sustainable change. However, there are several goals banks need to prioritise to fulfil this potential.
The Intergovernmental Panel on Climate Change (IPCC) stated that limiting global warming to 1.5 degrees Celsius requires a "rapid and far-reaching" transformation of the global economy, including the banking and financial sector. Banks must adopt a more responsible and sustainable approach to their operations. This can involve investing in renewable energy and other sustainable businesses, supporting local communities through philanthropy and volunteerism, and implementing strong social and environmental standards across all of their activities.
Additionally, banks must prioritise transparency and accountability, ensuring that they are fully accountable to their stakeholders and actively working to address any adverse impacts of their operations. These include:
Environmental degradation
Banking contributes to environmental degradation by financing environmentally damaging projects such as fossil fuel extraction, investment into carbon-intensive industries, deforestation, and lack of support for renewable energy. A report by Rainforest Action Network found that fossil fuel financing from the world’s 60 largest banks has reached $4.6 trillion in the six years since the adoption of the Paris Agreement, with $742 billion in fossil fuel financing in 2021 alone.
Economic inequality
The banking sector is linked to exacerbating economic inequality by promoting policies that benefit the wealthy at the expense of the poor. According to Oxfam, the richest 1% holds 45.6% of global wealth, while the poorest half has 0.75%. The banking sector plays a significant role in perpetuating this trend. It injects trillions of public money into the global economy, driving up prices of assets belonging to already wealthy company owners and shareholders.
Increased debt burden
The debt trap is when individuals or countries find themselves unable to repay their debts, leading to a cycle of borrowing to cover their previous debts and eventually sinking deeper into debt. We must consider the broader systemic and structural factors contributing to the problem. Still, banks play their role, for example, by lending to individuals or countries that cannot repay their loans, imposing harsh conditions on loans, such as austerity measures, that can lead to economic contraction and increased debt burdens. According to a report by the Jubilee Debt Campaign, 64 countries spent more on debt payments in 2019 than on healthcare.
Vulnerable groups exploitation
The banking sector engages in exploitative lending practices that target vulnerable populations through misleading advertising, pre-contractual information and excessive fees. According to the Finance Watch in-depth study, payday loans, often taken out by the most vulnerable consumers, have an average APR (Annual Percentage Rate) of around 1447% and can be as high as 5632%. These loans are extremely dangerous from the consumer protection perspective, as they can put vulnerable consumers in a spiral of over-indebtedness, low financial means, and low quality of life.
Support of irresponsible and unethical practices
Inadequate regulation in the banking sector can allow for irresponsible and unethical practices. It has been a significant problem in the past, leading to financial crises as well as environmental degradation and economic inequality. What's needed are measures such as
- setting limits on lending and investment activities,
- requiring transparency and disclosure,
- implementing consumer protection rules,
- and monitoring suspicious transactions.
Other actions, such as mandatory sustainability reporting, carbon pricing, and requirements for sustainable lending practices, can effectively promote sustainable finance and reduce the sector's negative environmental impact.
Investor pressure for short-term profits
Investors prioritising short-term profits over long-term sustainability can result in companies engaging in unsustainable practices to meet short-term financial targets. This approach harms the environment and exacerbes social inequalities in the process. It is not only morally indefensible but also poses significant risks to the stability of our financial system and the health and well-being of communities.
Please contact us if you want to know more about the specific ESG impacts and risks in your sector and the important upcoming legislation that will affect organisations in this area. We can develop an overview analysis and discuss the key ESG areas your business should focus on.
Jana Pavelková