Home Banking The Future of Sustainable Banking Looks Bright

The Future of Sustainable Banking Looks Bright

by internationalbanker

By Samantha Barnes, International Banker


The last decade has been among global banking’s most impactful. With seismic disruptions to the sector coming from all angles—from fintech (financial technology) startups upending traditional banking models and the coronavirus pandemic spurring dramatic digital-banking innovations to sharp interest-rate hikes triggering this year’s major banking crises and swelling lenders’ toxic debt exposures—the sector’s resilience seems to be continuously under threat. But amidst these headwinds, sustainability arguably represents the brightest opportunity for global banking prosperity.

Moreover, the sustainability theme is rapidly gaining traction among banking leaders, investors and the wider population, not least due to sustainable finance’s tangible impacts on the planet. According to Morgan Stanley, for instance, assets under management (AUM) for sustainable equity and fixed-income funds reached a record 7.9-percent share of the total global AUM in the first half of 2023. And despite having largely been a niche area for banks during much of the 2010s, the creation and subsequent steep growth in popularity of sustainability-linked financial instruments have led to this topic being increasingly positioned front and centre within banks’ strategic frameworks over the last two to three years.

Some envisage a new phase of sustainable finance dawning upon the banking sector, whereby solutions are designed to serve all industries and thus more comprehensively support the heavy lifting required for the world to realise a low-emissions future. The first phase was marked by financing mainly being allocated to clean-energy projects, McKinsey & Company reported in December 2022, while this new phase will see sustainable banking broadening and deepening to encompass new aspects of the global energy transition, including the growth of electrification, build-outs of energy transmission and distribution infrastructures, and reductions of emissions across numerous sectors. The consulting firm also stated that it expects spending on the physical assets required to meet net-zero emissions goals to provide commercial-finance institutions with an annual direct financing opportunity of around $820 billion.

Many of these opportunities will arise from the constantly expanding universe of tradable sustainable-finance instruments offered by banks across lending, investment banking and capital markets, including:

  • Green bonds: Bonds issued to raise funds for projects that benefit the environment.
  • Sustainability bonds: Similar to green bonds, but their proceeds are used to finance projects that deliver environmentally and/or socially beneficial outcomes.
  • Social bonds: Bonds intended to raise funds for projects with socially beneficial implications, such as improving community welfare.
  • Sustainability-linked bonds: Debt provided to improve the borrower’s sustainability profile and/or align the borrower with specific sustainability performance targets. Sustainability-linked loans are performance-based financing options that tie loan-repayment rates to achieving agreed sustainability targets.
  • Transition bonds: Bonds issued by organisations within carbon-intensive industries to help support decarbonisation efforts.
  • Clean-energy project finance: Loans that fund clean-energy projects, such as low-emission generation, sustainable fuels and grid-scale storage.

According to Moody’s quarterly “Sustainable Finance Update: Q3 2023”, the global issuance of sustainable bonds in the second quarter of 2023 across four main segments—green, social, sustainability and sustainability-linked (GSSS)—reached $258 billion, largely unchanged from the same period last year. Nonetheless, the asset class reached a hefty 15 percent of the global bond market.

Moody’s also explained that it expects total global sustainability-bond issuance to exceed the rating agency’s initial 2023 forecast of $950 billion, despite the challenging market environment. However, growth in the second half of the year “could be tempered by a drop in the number of first-time sustainable bond issuers, declining issuance in some markets such as the US, and the potential for higher borrowing costs and tighter lending to curtail global macroeconomic growth,” according to Matt Kuchtyak, vice president of sustainable finance at Moody’s Investors Service.

The global banking sector is predicted to play a significant role in this issuance upswing. This year, banks continue to account for a significant chunk of the sustainable-bond market, with ING noting that credit institutions globally issued more than €70 billion in EUR sustainable bonds from January through October, more than €10 billion above the sustainable supply over the same 10-month period in 2022. Moreover, the Dutch bank has projected that banks’ issuances of green, social and sustainability bonds will reach €80 billion this year—€8 billion more than in 2022.

McKinsey has forecast that the global banking sector could facilitate an additional $1.5 trillion of investments for corporates between 2021 and 2030, although lenders must first address critical issues to sufficiently capture all the sustainable-finance opportunities that will present themselves. Indeed, the banking industry must acknowledge the oncoming issues confronting sustainable finance, which must be resolved before this burgeoning sector can evolve. And with new instruments yet to be defined, highlighting the standardisation and harmonisation challenges facing the sector, the measurement and the reporting of sustainability-related performance represent distinct problems. For example, key performance indicators (KPIs) for sustainability-linked bonds have not yet been standardised.

Much of the challenge pertains to accurate data being transmitted and recorded by all parties. With ESG (environmental, social and governance)-compliant behaviour from banks, investors and other relevant stakeholders increasingly being baked into financial transactions worldwide, regulators must coordinate to ensure the transparency and reliability of the crucial data needed to verify such transactions. For instance, the European Union’s (EU’s) Corporate Sustainability Reporting Directive (CSRD) requires more than 50,000 public and private companies to disclose ESG factors starting next year, including more than 10,000 non-EU headquartered companies worldwide, with those affected having to conduct “double materiality” assessments to disclose issues impacting the business (financial materiality) and the environment or broader society (impact materiality).

“With these more robust disclosure rules coming online, particularly in Europe, investors and other stakeholders will have access to more specific data in the public domain,” according to Jamie Martin, head of Morgan Stanley’s EMEA Sustainability Office. “In the coming decade, it will be interesting to see how this information will allow investors to better evaluate a company’s sustainability performance, including revenues, corporate practices and supply chain. Such transparency could have wide-ranging impacts on companies, fund flows, data providers, rating agencies and index providers.”

“Only a small percentage of banks have near-term capabilities to finance some of the most dynamic burgeoning areas, including grid-scale infrastructure, green hydrogen, green fuels, biomass, and carbon capture and storage,” McKinsey also explained in its report “Global Banking Annual Review 2022: Banking on a sustainable path”, published in December 2022. “Challenges include credit risk, complex project economics, and lack of established standards for sustainability-related financial products. But new instruments, new markets, and new revenue pools beckon for those corporate and investment banks, lenders to small business and retail customers, and wealth managers, among others, who step [in] willingly.”

Whether banks can continue to deliver sustainable-finance activity in 2024 at the same pace as this year remains to be seen. But given the higher-for-longer interest-rate regime that central banks, led by the US Federal Reserve (the Fed), are now touting with growing frequency, the sector may be unable to deliver the same volumes as the general lending appetite continues to slow.

ING has stated it expects banks to issue €75 billion in sustainable EUR debt in 2024, which would be €5 billion less than the bank’s full-year estimate for 2023. “While banks will still issue notable amounts of sustainable debt in 2024, slower lending growth will probably make it difficult for them to continue to issue at the same pace as this year,” ING’s head of financials sector strategy, Maureen Schuller, explained. “We expect to see slightly less sustainable supply next year, despite our forecasted modest rise in total bank supply.” Nevertheless, the bank also observed that, against the backdrop of evolving ESG regulations and the more intense urgency demanded by investors and society at large for companies and banks to become more sustainable, lenders with highly sustainable loan books would continue to see “better growth dynamics” than those with less sustainable loan portfolios.

According to Morgan Stanley, meanwhile, a raft of sustainability-linked investment opportunities will become popular over the next 10 years, including nature and biodiversity, transition finance (funding companies’ transitions to net-zero) and inclusive finance (offering financing to underrepresented people and communities). “Social issues should also continue to gain prominence on investor agendas, with growing attention to issues such as the privacy and ethical implications of artificial intelligence; racial, gender and LGBTQ+ diversity; access to affordable housing, healthcare and education; and the disproportionate social implications of physical climate events,” the bank added.


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