Financial institutions around the globe are increasingly responding to stakeholder demands on sustainability and environmental, social and governance (ESG) actions by articulating a corporate purpose and explaining how that purpose will drive their decision making. Sustainability within the context of banking and financial services manifests in two forms:

1. Greening finance – How do financial institutions ensure their operations are green? How do they limit their own footprint?
2. Financing green – How is sustainability supported via the business strategy? How is capital allocated, and how are portfolios aligned with green enterprises?

While the second form is, arguably, the most demanding undertaking, both are crucial considerations in the net-zero context.

Financial institutions of all stripes must start acknowledging these facts, particularly given the increasingly tough sustainability directives that are on the horizon, namely the European Union’s Sustainable Finance Disclosure Regulation’s (SFDR), the Corporate Sustainability Reporting Directive (CSRD), and the Task Force on Climate-Related Financial Disclosures (TCFD) framework.

“What differentiates financial institutions from other organisations is the fact they have a huge role to play in facilitating the green economy,” Subramanian Kuppuswami, global head of sustainable banking and investments, Tata Consultancy Services (TCS), told Finextra. “This is why sustainability within a bank’s business strategy has a whole lot of potential.”

Otherwise described as scope three emissions, the downstream impact of a financial portfolio often constitutes the bulk of a bank’s carbon footprint and must therefore be tracked and mitigated. To meet the objective, financial institutions have begun leveraging environmental, social, and governance (ESG) data and technology – powering science-based decision making, as well as accurate, standardised ESG scoring.

Greening finance

First, however, a bank must make its own footprint (scope one and two emissions). Once again, technology and data play a huge role here.

In an interview with Finextra, an OakNorth Bank spokesperson said: “As a young, digitally led lender that has never lent to businesses that are engaged in oil or gas production, our carbon footprint is less than many other larger and older institutions. As a business, we started our sustainability journey in 2019 by offsetting our scope one and two emissions in order to be net carbon zero.”

The infrastructure problem

Given their sprawling data infrastructures, energy consumption is one of the biggest concerns for digital banks like OakNorth. According to a recent report from Galaxy Digital, the financial industry consumes 263.72 TWh per annum. For comparison, the notoriously energy intensive Bitcoin system consumes less than half of that; 113.89 terawatt hours (TWh) a year, to be exact.

The solution, however, is not to simply ‘virtualise’. Cloud providers are often responsible for vast data centres that are necessarily kept at cool by powerful fans. If the energy that powers these operations is unclean, then neither is the solution.

“Now that virtualisation has kicked in,” observed Subramanian, “banks have the option of dropping their hardware and moving their payloads into the cloud. But this creates a new challenge which is monitoring from where a given provider derives its energy. Is the cloud service powered by clean forms of energy, such as hydropower, or does it come from brown fuel, such as coal or gas?”

This is a vital consideration. According to the Energy and Climate Intelligence Unit, 43% of the UK’s electricity was derived from fossil fuels in 2019. Unless disclosed, it is the purview of financial players to understand if their cloud provider sits in that brown bucket.

Thankfully, according to Subramanian , “IoT-based sensor technologies are available, which can be used by banks to understand the exact levels of energy consumption that are occurring, what the usage patterns are, and escalate anomalies.”

“Once you do enough data gathering, these solutions have the ability to churn out analytics and insights, that provide an extremely holistic view of the infrastructure setup,” noted Subramanian.

The software problem

The mission to ‘green finance’ becomes no less complex when looking at software. According to research by Lancaster University, the information and communication technology industry contributes about 2.1–3.9% of the total global greenhouse emissions. While this is lower than other sources, it is expected to exponentially increase in the coming years, given the rapid growth of digital transformation and artificial-intelligence-based applications.

So, how do we measure the carbon footprint of a given piece of financial software, which most likely has accumulated inefficiencies and technical debt? How do we identify energy hotspots? How do we optimise software sustainability across the lifecycle – from architecture, design, and coding to deployment? Answering these questions is critical to satisfying banks’ net-zero aspirations.

According to Subramanian, there are many ways to become more energy efficient, but in terms of programs and operating information, green software engineering techniques should be practiced. This includes implementing architectures supported by green software principles – such as Web-Queue-Worker, N-tier, and Microservices – which are already being leveraged by some players in the industry.

“Before you write a piece of code,” warned Subramanian, “stop and ask whether you really need a huge fancy machine learning algorithm to do a simple arithmetic calculation? Maybe not.”

The ‘S’ and ‘G’ elements

Naturally, ESG issues are not just confined to the environment. Social and governance issues must also be considered in the pursuit to ‘green finance’. For instance, “how should banks make their software or IT landscape more accessible and inclusive to neurodivergence?” asked Subramanian.

According to the World Health Organisation (WHO), nearly 15% of the planet’s population lives with some kind of disability. That is over one billion people who may struggle to access life-enhancing financial services.

“Most of the time banks don’t pay a lot of attention to this when developing their applications,” Subramanian pointed out. “Can they be used by people who may not be able to recognise colours, or cannot be read, for instance?”

Fortunately, there are manifold solutions to this issue, including, for example, automated accessibility compliance testing for webpages, and tools that convert content into formats such as Braille, DAISY text, DAISY audio or Epub3. There are also voice recognition, text-to-voice, and audiobook technologies.

Here are just some examples of the social and governance considerations facing banks today. There are also considerations such as staff welfare, ethical labour practices, gender parity, diversity and inclusion, improved compliance processes, and increase transparency for all stakeholders. Being aware of each ESG issue and managing them through data and technology is imperative to greening finance.

Financing green

Banks’ mission to go green is a financially sound pursuit, as much as it is environmentally and reputationally. Evidence suggests that purpose-led, ESG-linked firms perform better in the long-term – having demonstrated enhanced economic resilience during the Covid-19 pandemic, and since.

The key, therefore, is for financial institutions to ensure their investment portfolios are as sustainable as possible – deploying the latest in technology and data to separate the wheat from the chaff.

Multinational banking and financial services organisation, HSBC, is one financial player that is committed to supporting corporate clients in their journey to net zero. Natalie Blyth, global head of sustainability, HSBC, told Finextra: “As the world’s largest trade bank, HSBC is in a unique position to offer solutions which enable a green transition across end-to-end supply chains.”

For some firms, this will mean a wholesale change to plan for, but for others it may be a short, single change in the way their business is conducted. In the case of UK-based fresh fruit grower and supplier, DPS, HSBC provided a green loan that enabled the firm to pioneer new vertical farming techniques at their strawberry farms. The investment enabled DPS to produce 90% less CO2 per kilogram than traditional farming methods. What’s more, as a result of the sustainable finance deal, DPS has been able to cut its water usage by 80%, reduce chemical consumption, and boost production eightfold. This is just one of many ways banks can engender on-the-ground, positive changes in the economy.

“We’re no longer talking about the negative impact of companies, but instead ensuring investments are engendering a positive environmental impact,” said Subramanian.

Tools of the trade

“As well as providing sustainable finance solutions,” stated Blyth, “HSBC leverages our data and expertise to co-create solutions with clients that support their transitions. We see the need for both larger corporates and SMEs to have access to carbon calculators, ESG disclosure portals, simple sustainability assessment tools, as well as more complex tools that help corporates visualise the transparency of their supply chains.”

Such tools are foundational in the fight to ‘finance green’. They help identify the parameters needed to build sustainable frameworks and can directly contribute to scoring methodologies. Once again, data – be it in-house, or from external providers via APIs – along with an analytics framework, supported by artificial intelligence (AI) and machine learning-based algorithms, is vital for a 360-degree ESG view.

With disclosed ESG information, banks can compare and analyse performance, evaluate sustainability risks, and enhance their portfolio construction.

“We are one of the first banks globally to have stress tested the possible impact of climate risks on our loan book,” OakNorth told Finextra.

According to the bank, the forward-looking scenarios within the solution are constantly updated with the most recently available data, including high frequency third-party data sets, in order to ensure the scenarios are providing the most accurate view of climate impact – at any point in time, across all industries in the loan portfolio.

“This enables us to manage, measure and mitigate climate risk by quickly identifying sectors that have greatest climate risk and create effective transition strategies, identify additional lending opportunities with new and existing borrowers, and avert future losses.”

Indeed, many banks are working to put together better, more granular data, and there is a recognition within the industry that the effects of climate change can be highly localised. Banks therefore need to be looking at both geographical granularities as well as industry sector granularity.

“Take an example of the automotive industry in the US where there are approximately 20,000 new car dealerships, 150,000 used car dealers, and 250,000 auto repair and maintenance centres,” said an OakNorth spokesperson. “All these businesses are being impacted by increasing demand for electric vehicles which require far less maintenance than an internal combustion engine and have far fewer moving parts. Banks need to use data to develop an understanding of the loan level risks they’re taking on to their balance sheet on behalf of their borrowers.”

Now that the necessary data and technology is emerging, it will make banks’ lives easier: “The idea is to bring together data sources, even from the most granular levels, and derive actionable and transparent insights around the ESG performance of companies,” stated Subramanian. “This is vital for the long-term prosperity of portfolios.”

Indeed, the financial industry must move away from exclusionary methods and espouse positive and inclusive capitalism. As data becomes increasingly available, stewardship and engagement are the only sustainable options.

Fortunately, some institutions are working these sustainable goals into their business strategy. OakNorth is one of them: “We have committed to achieving net zero by 2035 for all our emissions, including all scope three from our lending activity. We don’t yet have all the answers as to how we will achieve this, but as a bank that lends to high-growth businesses, a big part of doing so will be in we helping our borrowers make the necessary changes and investments in their business models and operations to reduce their carbon footprints.”

Collective, consistent, and credible action

We do not need another climate report to confirm that biodiversity is in free fall around the world. Both the individual and the corporate have a shared responsibility to address their footprints, however small.

Banks, on the other hand, are in the unique position of being able to engage with and influence the ESG trajectory of countless businesses in the real economy. It is this principle that renders a financial institutions’ commitment to sustainability dualistic: on the one hand they have a responsibility to ‘green finance’ and on the other, ‘finance green’.

According to McKinsey, the capital spending necessary to achieve international climate goals could over $9 trillion annually. This represents a huge opportunity for commercial institutions to help their business borrowers transition to the green economy – whether by helping homebuilders invest in greener building materials; or restaurants introduce more plant-based food options to their menus; or enabling retailers to switch to recycled packaging materials; or providing farmers with the capital to invest in more sustainable agriculture products. The list goes on.

This is an exceedingly complex and time-consuming undertaking and will only be achieved with access to rich data, and the technology to digest it. The importance of collective, consistent, and credible action cannot be overstated here, so financial firms will need to assume a leading role in shaping initiatives to accelerate the transition.

HSBC’s global head of sustainability noted that “partnerships – not just with other financial institutions, but with customers, technology providers and a range of other stakeholders – are the heart of the approach to ensure emissions are removed from the economy in a fair and just way.”

Banks can even leverage technology to bring social benefits to commercial enterprises, too. For instance, OakNorth told Finextra: “Data and technology can help banks find a path to ‘yes’ for businesses, rather than a computer-says-no type of response. This could unlock more lending for SMEs and businesses who will in turn create new jobs, build new homes, increase productivity, develop new innovations, and generate GDP growth. In the UK, the £7.5 billion OakNorth has lent to date has supported the creation of 31,600 new jobs and 22,300 new homes across the UK – of which the majority are social and affordable housing.”

So, there is a clear social benefit of using data and technology to unlock more lending to businesses. On the governance side, however, it can provide more transparency around the data banks use to make lending decisions: “Several of the banks that our sister entity is working with say one of the benefits of leveraging software is to provide an independent, third-party perspective on credit risk,” OakNorth said to Finextra.

Throughout the pandemic, banks were given a unique opportunity to rebuild some of the public trust and goodwill that was lost during the financial crisis 12 years earlier. Climate change provides another with sustainability set to be the growth story of the 21st century – and with the right technological investments, strategic partnerships, and data, banks have an opportunity to be one of the key protagonists.