Kamal El Khoury, Managing Director, MENAT Lending, Finastra
Action on Environmental, Social and Governance issues (ESG) has rapidly transformed from being a ‘good to have’ to a crucial part of a company’s strategy and its long-term success. Indeed, ESG has become a board-level agenda in the MENA region. Particularly in the Middle East, the adoption of ESG principles is essential to the region’s efforts to diversify economies, improve the state of the environment, and create more opportunities for future generations.
Banks play a pivotal role in pushing this agenda forward. Not only do they need to consider the ESG impact of their own organizations, but they also need to demonstrate a duty of care to customers, other stakeholders and society-at-large in ensuring the lending decisions they make are responsible and sustainable.
We’ve recently seen some great industry progress in the region. For example, Mashreq Bank recently pledged to increase its sustainable financing to $30 billion by 2030 and Tabreed launched a Green Financing Framework to fund projects aligned with the UAE’s commitment to carbon neutral. These developments will need to continue evolving as customers, employees, investors and other stakeholders increasingly expect companies, and the banks that support them, to demonstrate their commitment to ESG in everything they do. With stakeholders, including NGOs applying pressure on banks, it’s imperative they take a closer look at the make-up of their loan portfolios.
For banks, measuring the environmental and societal impact of the entirety of their lending is not straightforward. For example, lending for green assets such as solar panels and wind farms has soared in popularity. Projects that would have struggled to get finance 10 years ago can now secure loans with very favorable rates. In the MENA region, green and sustainability-linked bonds and loans reached an all-time high of $18.64 billion in 2021, compared with 4.5 billion in 2020. Most banks will already measure today how many green assets they have in their loan books.
The challenge is that this doesn’t represent the entirety of the total lending banks do. For example, having 10% of assets classed as ‘green’ could still mean having 70% of assets, whether projects or companies, that are working to improve their green credentials or not planning to change at all. DIFC recently announced that businesses may soon be required to comply with a minimum set of ESG standards for the nation to achieve net-zero emissions by 2050. To help businesses achieve these ESG goals, banks need to go beyond financing projects that are green already and support those companies and industries that are actively looking to improve.
To help measure this, banks must aim to capture the rate of improvement over time. Not all companies are rated by a sustainability agency, so it can be difficult to quantify exactly where a company sits on the ESG scale. Being too flexible with definitions puts banks in danger of ‘greenwashing’, so taking a consistent and systematic approach in their assessments is crucial. Banks should assess tangible improvements companies are making now and in the near term. This insight is far more valuable than goals set 10-15 years from now.
Another challenge is the risk of creating a shadow industry which doesn’t apply the same ESG principles. If banks avoid financing polluted assets and industries that still have 20+ years of life, there’s a risk of creating ‘stranded assets’. Rather than avoid them completely, regulators and governments will want banks to encourage businesses to clean up their act where possible.
For governments and regulators, the impact of issues such as climate change on economic stability is also a major concern. In response, they’re asking banks to assess how the risk of increased floods, drought and forest fires could impact all companies in their loan portfolios. Floods and forest fires may seem largely insignificant in the Middle East, but many banks in the region lend to global companies with subsidiaries right across the world – and it’s a real challenge to gather all relevant data and measure this risk. This should not delay action though. Banks need to start collecting and analyzing the data points that are available now and provide intelligence on where the risks lie. This is not possible without technology.
With technology, companies can demonstrate their compliance with rigorous ESG standards so that they can apply quality control marks that show purchasers their adherence to green, social and governance targets. Blockchain technology, for example, can be used to track a product’s lifecycle end-to-end. This can include the source of the raw materials, the transportation and production processes and carbon footprint all the way through to the point of sale.
Banks need solutions that capture and process the required information to measure and understand the percentage of assets in their lending portfolio that are green or ‘greening’. They can then embed intelligence into their lending process which helps them track the ESG performance of each company they lend to, and factor this into future loan pricing. The higher the proportion of green or ‘greening’ loans a bank offers, the more it could ultimately increase its bottom-line. A UAE study revealed that increasing the proportion of green loans in a bank’s overall loan portfolio lowers the non-performing loans (NPL) ratio.
According to PwC, developing the right structure and mechanisms for green finance could help the GCC region unleash a tremendous opportunity: $2 trillion in economic growth and more than 1 million jobs by 2030. Achieving this requires an open environment where everyone can come together and play their part in delivering against ESG goals for the good of all.