The importance of ESG in banking

In recent years, a broad understanding and recognition has emerged that climate and environmental factors pose all kinds of risks for financial institutions. That’s why regulatory requirements are implemented at a rapid pace, such that climate-related risks are better quantified, monitored, and mitigated, including under stressed scenarios. In addition, newly imposed regulations require financial institutions to report their climate impact and their exposure towards climate related risks. This shift is also noticeable in the strategy and governance of financial institutions, resulting in an increasing number of investment strategies incorporating sustainable investment goals to contribute to an accelerated transition.

Integrating Environmental, Social, and Governance (ESG) factors in decision-making processes will have a significant impact on the long-term performance of banks by mitigating risks. This ESG risk integration will also play an important role in financing the transition.

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Integrating ESG factors in existing risk management frameworks and risk models

With our years of experience in data management, risk models, climate- and environmental risk assessments and sustainable finance, Amsterdam Data Collective can support financial institutions in meeting the incremental expectations of ESG in banking. Our ESG in banking team can offer support and knowledge regarding ESG data availability and governance, ESG risk integration, climate risk assessments, and climate risk stress test frameworks.

Amsterdam Data Collective specialises in integrating ESG factors in existing risk management frameworks and risk models, as well as developing new frameworks to get a more accurate picture of these types of risks to manage and mitigate these in accordance . This can lead to overall better decision-making and improved financial performance.

The struggles of banks when integrating ESG factors

The European Central Bank has set deadlines for banks to progressively meet all supervisory expectations by the end of 2024. However, stepping up the management of climate and environmental risks can bring many difficulties. Our ESG in banking specialists consider these the biggest challenges:

Financial institutions are struggling to integrate ESG data and implement sophisticated methodologies
While most banks have implemented basic practices regarding ESG in banking, most of them still struggle with implementing sophisticated methodologies on climate and environmental risks. Understandable since ESG regulations are fairly new and implementing new methodologies is a complex task. Significant challenges here are data availability and modelling techniques.
Nevertheless it’s very important for banks to focus on this – underestimating the magnitude of climate and environmental risks can have a significant impact.

A lack of one common approach in identifying and managing climate and environmental risks
As mentioned above, banks are integrating climate and environmental risk factors in their governance and risk management practices. However, many of the risk identification activities are more ad-hoc and take place in silos of the bank. Often, it is observed that ESG data is very fragmented within banks, including a lack of alignment across different departments and strategies.

A wait-and-see approach
The EBC expects banks to include climate and environmental risks in their governance, strategy, and risk management by the end of 2023 at the latest. Although the majority of Dutch banks have clear strategies to meet these deadlines, other, often smaller banks that are not directly supervised by the ECB, are still maintaining a wait-and-see approach.

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What ADC can do for banks, and broader for financial institutions

At Amsterdam Data Collective, we know how important it is to integrate climate and environmental factors in banking. We can help banks, and broader financial institutions, in different areas.

Our ESG banking solutions exist to integrate climate and environmental considerations into risk management processes. This provides a more comprehensive and accurate assessment of these types of risks and promotes sustainable and responsible business practices. We can support organisations in overcoming challenges of data availability, enhancing methodological approaches to assess climate and environmental risks, and developing a stress testing framework.

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Domain of expertise 1: ESG data availability & governance

ESG data is needed to reach objectives within different domains:

  • Strategy setting & execution,
  • Risk monitoring & management, and
  • Compliance & reporting

However, this is only achievable if your data maturity and data architecture are up to par to foster trust in the products built, exercises executed, and their outcomes. Additionally, there must be a clear ESG foundation and strategy, which involves not only data quality, but also data controlling, connectivity, and accessibility.

One important domain Amsterdam Data Collective can help with is supporting organisations to bring their data maturity up to par. ADC has extensive experience in this field and can conduct our proprietary data scan to consider the maturity of the company, personalising a framework for building an ESG platform that best suits the needs of your organisation. Altogether, this will contribute to consistent ESG metrics and insights across departments, which will support your bank’s transparency and reporting.

Read more about understanding the urgency for setting up an ESG data architecture in the financial sector.

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Domain of expertise 2: Climate Risk assessment

It is widely acknowledged that climate and environmental factors are drivers of financial risks by means of both the transition and physical channel. However, the approaches to assessing the materiality and impact are limited in both depth and sophistication. This presents new climate-related challenges for risk managers.

ADC is ready to support our clients to quantify the impact of these risks on bank’s exposures. We conduct impact analyses of climate and environmental risks to assess how these risks affect balance sheet assets and banks’ strategies. We are skilled in enhancing methodologies and approaches to integrate these insights in risk frameworks and monitoring systems, as well as developing and implementing ESG metrics and KPIs. ​We also have experience in integrating ESG factors in modelling and ICAAP/ORSA frameworks.

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Domain of expertise 3: Climate risk stress testing framework

As part of the annual Supervisory Review and Evaluation Process (SREP), European banks are expected to assess their internal capital position under stressed scenarios in their ICAAP. However, 60% of EU banks do not have climate risk stress testing frameworks in place.

Our ESG team developed an approach to translate ESG scenarios of the Network for Greening the Financial System (NGFS) into bank specific scenarios, both for the short and long term. These can be applied on a bank’s portfolio to quantify the impact on risk parameters and explore possible impact on their strategy.

Besides the quantitative approach, we also include a qualitative angle to this process by organising an expert session workshop to ensure that the impact is realistic for a bank’s balance sheet, yet stays in line with market practice.

This approach will work towards a tailor made solution for a bank’s balance sheet. Outcomes of the assessment are no black box, and argumentation for certain decisions and assumptions are clear and transparent, in line with supervisory expectations.

Do you want to know more about the ESG framework in banking?

Take a look at our blog “Understanding the Urgency for Setting up an ESG Data Architecture in the Financial Sector” in which we dive deeper into why ESG data is relevant, which challenges are associated with ESG data and metrics, and how we can help you improve your ESG data infrastructure. Of course you can always contact us for more information!

 

ESG stands for Environmental, Social and Governance factors. These are factors to evaluate companies on how advanced they are regarding sustainability.

The ESG framework helps organisations understand how they can manage risks and opportunities regarding ESG (the environmental, social, and governance criteria).

By investing time and energy into the ESG frameworks, banks can meet regulatory requirements. Other than that, it also enhances their reputation and credibility with clients and stakeholders.

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