ESG in China’s Banking Industry: Developments, Challenges and Outlook

By Dr. Oliver Rui, Professor of Finance and Accounting, CEIBS, and Director, CEIBS Wealth Management Center, and Adrian Guo, Research Assistant, CEIBS Wealth Management Center

The United Nations Environment Programme Finance Initiative (UNEP FI) Principles for Responsible Banking make it crystal clear that banks should take action to align their core strategy, decision-making, lending and investing with the UN Sustainable Development Goals (SDGs) and international agreements such as the Paris (Climate) Agreement.

Policies

With the Chinese government promising to achieve peak carbon emissions in 2030 and carbon neutrality in 2060, China’s banking sector, as the core of the country’s financial industry, has started to step up in shouldering its responsibility for sustainable development.

In a move to prioritize environmental, social and governance (ESG) development, the China Banking and Insurance Regulatory Commission (CBIRC) released its “Green Finance Guidelines for the Banking and Insurance Industry” in June 2022. This directive has elevated the significance of ESG development in the banking industry to a strategic level, mandating that banks integrate ESG requirements into management processes and comprehensive risk-management systems. This marks a pivotal moment regarded as animportant node in the history of ESG development in China, as the ESG practice has become an inevitable choice for the banking industry under the government’s goal-based strategy.

The impressive results achieved by China’s banking sector in promoting sustainable development indicate the industry’s commitment to addressing environmental challenges and promoting long-term economic growth. Bythe end of 2022, China’s green-loan stock had surged to 22.03 trillion CNY, demonstrating the significant strides made in promoting green finance throughout the country. Moreover, the green-credit balance ofdomestic banks has been on an upward trajectory since 2018, achieving a compound annual growth rate of 41.40 percent by the end of the third quarter of 2022.

These impressive figures highlight the banking industry’s unwavering dedication to promoting sustainable development domestically. ESG development plays a crucial role in helping to address environmental challenges, and the impressive growth rate of green loans in China signals the industry’s commitment topromoting sustainable economic growth. It is evident that China’s banking industry plays a critical role insupporting the country’s transition toward a sustainable future. This commitment to sustainable development will undoubtedly positively impact the country’s economy and the world’s environment.

Developments and challenges

Generally, ESG criteria have gained prominence in the global financial market as investors and stakeholders have become more conscious of the impacts of their investments on the environment, society and corporate governance. China’s banking sector, one of the largest in the world, has not been left out of this trend. However, while there has been an increasing awareness of ESG strategies among Chinese banks, implementing them isstill in its early stages.

For example, the Industrial and Commercial Bank of China (ICBC), one of China’s largest banks, has made somestrides in implementing ESG strategies. In its “2021-2023 Development Strategic Plan,” the bank outlined its objectives, paths and tools for constructing a green financial system. The bank plans to support low-carbon industries, promote the carbon-reduction transformation of investment and financing portfolios, strengthen climate-risk management, and consolidate the foundation of investing in and financing carbon measurements. These targets have become the “Four Pillars” of ICBC’s green financial strategy. In addition to large state-ownedbanks and some joint-stock banks, however, most listed banks are still in the initial stages of ESG strategic planning, either due to a lack of awareness of ESG or a shortage of professional teams. Moreover, limited informative disclosure reports also impede the development of ESG strategies. As a result, the disclosed ESG strategic planning lacks quantitative strategic objectives and clear key initiatives or implementation paths.

Moreover, effective organizational structures and management mechanisms are essential for promoting ESG work efficiently within an organization. A clear division of labor at all levels within the organization can help to ensure the strategic implementation of ESG and the orderly progress of various projects. A complete ESG organizational structure should include three Governance-Management-Execution (GME) levels. All threelevels should clarify their responsibilities in ESG business and management.

Based on related data from Wind, all listed banks in China have set up departments in charge of ESG in their headquarters. Most banks have also clarified their GME structures. Large state-owned banks have formed complete governance structures, while joint-stock and rural commercial banks have chosen existing departments to serve as their ESG operation teams. Urban commercial banks, on the other hand, have set up brand-new, separate departments. According to disclosure reports, some banks has also started to disclose the establishment of an ESG-management department at its branch level. This could have a positive consequences for China’s banks’ overall ESG performance in the future.

Let’s focus on two examples illustrating the ESG-development trends in China’s banking industry: Postal Savings Bank of China Co., Ltd. (PSBC) and Industrial Bank Co., Ltd.

PSBC, one of China’s six biggest government-owned banks, has established an environmental and social-riskmanagement system and carried out hierarchical management of clients while granting credit. The bank has integrated ESG and climate risk into its corporate customer credit investigation and review-reporting templates and included ESG-related risk indicators in its internal rating-adjustment factors. This approachenables the bank to evaluate the creditworthiness of its customers based on ESG considerations and adjust its internal ratings accordingly.

The Industrial Bank Co., Ltd., one of China’s largest joint-stock banks, has implemented an overall differentiated ESG credit and risk-control strategy for corporate, interbank and retail credit clients. The bank has developed an ESG and climate risk-management policy and an ESG-related credit policy, as well as embedded ESG into its whole risk-management process. This strategy enables the bank to assess the environmental and social risks associated with its customers and adjust its lending policies accordingly.

These examples demonstrate the importance of integrating ESG considerations into the credit-granting process. By assessing the environmental and social risks associated with their current and potential customers, banks can make more informed lending decisions that support sustainable development. In addition,embedding ESG into their entire risk-management processes can help banks manage the risks associated with their lending activities better.

In conclusion, China’s banking industry is striving to integrate ESG considerations into its operations. Bankssuch as PSBC and Industrial Bank Co., Ltd. are leading the way by implementing differentiated ESG credit and risk-control strategies for their clients. As ESG considerations become increasingly important to investors and stakeholders, we can expect to see more banks in China and around the world following this trend.

Prospects for the future 

1. Enhancing professional At present, most banks in China still mainly focus on basictraining in ESG awareness and capability. Since the current bank talent pool is generally concentrated in the traditional finance and fintech (financial technology) fields, most banks have not carried out professional-talent echelon layouts in green finance, low carbon and ESGmanagement. The next step is to continue building professional abilities and improving ESG business and management levels through various measures. Another way for China’s banks to enhance their ESG professional abilities is to strengthen their disclosures of ESG information. Increased disclosures will improve transparency and accountability and help investors and stakeholders make informed decisions. Additionally, it will also enhance the reputations of Chinese banks and improve their access to capital markets.

2. Establishing incentive mechanisms. ESG investing has gained momentum in China, withinvestors increasingly considering ESG criteria when making investment decisions. To meet this growing demand, Chinese banks must step up their efforts to incorporate ESG criteria into theirdecision-making One of the ways to achieve this is by establishing clear ESG development goals and measures that align with their business objectives. Such measures will enable banks to integrate ESG considerations into their lending and investment decisions, positively impacting the environment and society. Most listed banks in China attach importance to constructing optimized incentive policies and should continue to deepen this focus. Commoncurrent incentive policies include differentiated credit policies (such as priority approval and giving preferential measures) and ESG-performance evaluation mechanisms (such as establishing green-credit evaluation indicators and adding green-loan indicators to annual branch assessments). Among the banks operating in China’s stock market, large state-owned banks have established the mechanisms mentioned above. More than half of joint-stock financial institutions and city and rural commercial banks have also clarified corresponding management measures.

3. Building organizational structures. Based on the GME structure and responsibilities, banks must set up separate professional committees or departments to guide and manage ESGdevelopments or consider adding chief sustainable development officers or equivalent positions to manage the work of ESG development. Banks should also consider to popularize ESG-management departments at the branch level. This would ensure that ESG considerations are integrated into branches’ decision-making processes and help promote a sustainability culture throughout the organization. Additionally, popularizing ESG-management departments at the branch level would improve the quality of ESG-data collection and reporting, which is essential to meeting the increasing demand for ESG information from investors and Ultimately, this will enhance the banks’ reputations and improve their access to capital markets.

4. Enriching product services. Currently, most financial products issued by China’s banks lack variety, innovative structure and inventive content. More specifically, commercial banks shouldactively explore products other than green credit; increase the issuance, underwriting andinvestment of securities such as green bonds; and actively participate in carbon markets and other businesses related to climate-change transformation finance. Tailoring the developmentaldirections of differentiated products and services according to their respective capabilities andlocal conditions is also crucial. Regarding product content: vertically, banks should explore product innovations related to climate themes, developing products pertaining to climate investment and financing and finance transformation; horizontally, they should investigate theconnotation of innovation related to sustainable development in addition to environmental andsocial themes, such as creating employment opportunities, financial inclusion and other relevant products that should be explored and developed.

While there is a growing collective awareness of ESG strategies in China’s banking industry, implementation still has a long way to go. Establishing clear ESG development goals and measures and strengthening ESG disclosures are crucial steps Chinese banks must take to incorporate ESG considerations into their decision-making processes. Ultimately, the successful integration of ESG criteria into their operations will not onlybenefit the environment and society but also improve banks’ long-term financial performances.