ESG risks can affect an entity's capacity to pay or meet its financial obligations. S&P considers these factors when making credit-rating decisions.
While banks are giving more attention to environmental and social risks, S&P said these factors are “less credit-relevant.”
“Governance is the factor that influences banks’ credit quality, in most instances,” said S&P.
For seven out of the reviewed financial institutions (14 percent), ESG credit factors were found to be directly influencing credit quality, more positively or negatively than peers.
At four of the seven banks, ESG factors influence credit quality more negatively than peers.
“We recognise ESG is becoming central in most banks' strategies and topics like climate change, treating customers fairly, ensuring proper governance and transparency rank high in board's agendas, likely more than a decade ago,” Pierre Gautier, Senior Director, Financial Services Ratings at S&P Global Ratings said.
“We also recognise that embedding ESG considerations in business settings or risk frameworks is a complex task, which takes time, especially the way banks are looking to support the transition to a carbon-neutral economy,” he added.
Governance, environmental risks
In terms of governance, the report looks at several factors, including the risk appetite and the strategy's stability, the quality of the management team, the board and the nature of their relationship, among other factors.
Another ESG factor is environmental risk. Banks are primarily exposed to environmental and climate risks via their lending and securities portfolios, due to physical and transition risks, S&P said.
The European Union (EU) already announced ambitious objectives for renewables to account for at least 32 percent in final energy consumption by 2030 and a net-zero carbon target by 2050.
“Banks and their clients have to embrace these objectives, or otherwise be exposed to credit, market, operational or liability risks, or simply be disrupted. At this stage, these factors are less directly credit relevant for banks, but the pace of change is rapid,” Gautier said.
In terms of social risks, the report noted that banks face social challenges, including how to avoid “reputational or regulatory risks” in retail activities, at the time when their commercial practices are increasingly being scrutinised and there are rising expectations from the population and regulators.
“Banks need also to carefully manage a transition to a workforce that has a different skill-set than before, and also, being essentially a human capital business model, adapt to the expectations of workers in the new economy,” Gautier said.
“As well, banks are susceptible to data privacy and security – IT breaches, a serious and common threat to the data-intensive industry,” he added.
(Writing by Gerard Aoun; editing by Cleofe Maceda)
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