The impacts of ESG materiality in the banking and financial industries

Elena Goudarzvand is an advisory intern within PKF Malta

The impacts of ESG materiality in the banking and financial industries are significant and multifaceted. ESG materiality refers to the extent to which environmental, social and governance factors affect the performance, risk and reputation of banks and financial institutions. ESG materiality can vary across different sectors, regions and stakeholders, depending on their exposure, sensitivity and adaptability to ESG issues.

Environmental, social and governance (ESG) factors are increasingly being used by investors, regulators and other stakeholders to assess the sustainability and ethical performance of companies. ESG materiality is the process of identifying and prioritising the most relevant and significant ESG issues for a company and its stakeholders. PKF has organised two public consultation events this year, one focusing on environment and another on social. A sequel will follow in autumn on governance.

Some of the key ESG issues that are material for banks and financial industries include:

1. Climate change: Banks and financial institutions are exposed to climate transition risk as they finance the economy and its transition to a low-carbon future. Climate change can affect the creditworthiness, profitability and resilience of their borrowers, as well as their own operations and reputation. Banks and financial institutions need to align their strategies, products and services with net-zero commitments and regulatory requirements, as well as measure, report and disclose their climate-related risks and opportunities.
2. Access and affordability: Banks and financial institutions play a vital role in ensuring broad access to financial services for the population and economic agents, especially in emerging markets. Access and affordability can affect the customer satisfaction, loyalty and retention of banks and financial institutions, as well as their social license to operate. Banks and financial institutions need to leverage new technologies, partnerships and innovations to enhance their financial inclusion and digitalisation efforts while also managing associated risks such as cybersecurity, data privacy and consumer protection.
3. Governance: Banks and financial institutions are subject to high standards of governance, ethics and accountability, given their central role in the economy and society. Governance can influence the trust, confidence and reputation of banks and financial institutions among their stakeholders, including regulators, investors, customers and employees. Banks and financial institutions need to ensure effective oversight, risk management and compliance systems, as well as foster a culture of transparency, integrity and diversity.

As of 18 May 2022, S&P Global Ratings published research on the ESG materiality map of the banking sector. The ESG materiality map provides an illustration of S&P Global Ratings’ view of the relative materiality of certain environmental and social (E&S) factors, from both the stakeholder and credit perspectives, for the banking industry. The map identifies a common, global, cross-sector set of E&S factors that are considered material to stakeholders and have the potential to impact the credit of entities in the banking sector.

The ESG materiality map highlights material factors, based on their impact on stakeholders and their potential to affect the creditworthiness and performance of banks and financial institutions, such as access and affordability, climate transition risk, physical climate risk, privacy protection, responsible marketing and labelling and employment practices, among others to guide stakeholders, including investors, regulators and companies, in understanding the relative importance of various E&S factors for the banking sector in order to align their strategies, risk management and reporting practices with the ESG issues that are most material to their stakeholders and their long-term sustainability.

The integration of ESG materiality can also bring negative impacts on the banking and financial industries. It may enhance the costs and risks of compliance with ESG regulations and standards, potentially reducing the profitability and competitiveness of traditional business models reliant on fossil fuels, carbon-intensive activities or unethical practices. Additionally, it can limit access to capital and financing for companies not meeting ESG criteria of investors, lenders or rating agencies. Moreover, exposing the industry to reputational damage, legal liabilities and social backlash if perceived as not aligned with ESG values or expectations of their stakeholders. Furthermore, ESG materiality presents challenges and risks, including increased complexity and costs due to data collection and reporting requirements, heightened scrutiny and pressure from stakeholders with differing expectations and introducing uncertainty and volatility into the market due to ESG issues affecting company valuation, performance and stability.

In summary, ESG materiality is not a one-size-fits-all approach. It requires a thorough understanding of the specific context, objectives and stakeholders of each bank and financial institution. It also requires continuous monitoring and evaluation of the changing ESG landscape and expectations. ESG materiality can help banks and financial institutions to adapt and thrive in a rapidly evolving world.

In the banking and financial industry, adopting proper and convenient ESG strategies is crucial for ensuring long-term success and sustainability. This involves integrating ESG considerations into decision-making processes, risk management frameworks and product offerings. Key strategies include aligning business strategies with global sustainability goals, such as the Paris Agreement and the Sustainable Development Goals, promoting financial inclusion and accessibility, managing climate-related risks and opportunities, enhancing corporate governance and transparency and fostering diversity and inclusion. Additionally, prioritising responsible investment practices, developing innovative financial products that support sustainable development and engaging in active stakeholder collaboration to address ESG challenges collectively.