ESG in the credit process
There is growing pressure on financial institutions to fully incorporate ESG-factors into their lending process. The 7th MaRisk amendment is expected to result in comprehensive ESG-implementation. The draft of the 7th MaRisk amendment has been available for consultation since September 2022. In addition, the EBA already published guidance documents in 2020 on lending and monitoring, and on dealing with climate and environmental risks. At present, the “E – Environmental” factor is by far the most important of the individual ESG-factors. The social and governance factors have so far played only a subordinate role. This is due, among other things, to the previous focus of regulatory requirements as well as to public debates.
The inclusion of ESG-criteria in the credit process is essential due to various aspects in addition to regulatory requirements. On the one hand, ESG-factors influence the company’s own credit risk and thus also its credit terms. Second, lending to borrowers who are predominantly not “green” could damage the company’s own reputation.
In order to include ESG-factors in the lending process, additional information about the borrower is required, as well as an assessment of the purpose of the loan in terms of ESG-criteria. The following is a list of possible activities to include ESG in the loan process.
Anchel Kalra
Managing Consultant in Risk Management
Possible activities within the scope of ESG-implementation projects
- ESG-analysis of borrowers: Which ESG-standards are met by the borrower (existing and new customers)? Based on this analysis, potential risks and opportunities can be identified.
- Require ESG-reporting from borrowers: Borrowers may be required to file an ESG-report on a regular basis. Thus, the sustainability of the borrower can be monitored over the entire period of the loan agreement and not just at the time the loan is granted.
- Inclusion of ESG-factors in risk assessment of borrowers: A higher risk can be applied to borrowers who score poorly on ESG-criteria.
- Development of ESG-credit guidelines: loans can be granted on the basis of an ESG-credit guideline that meet a specific ESG-standard and thus the sustainability of the company’s own loan portfolio can be improved in the long term.
- Linking loan conditions to ESG-criteria: If high ESG-standards are met, better credit terms can be granted.
- Granting of special credit products: Develop new credit products that target sustainable projects and initiatives, e.g., green loans, social loans, sustainable bonds.
Integrating ESG-criteria into the credit process not only serves to promote more sustainable business practices, but can also help improve risk management.
Outlook
The activities just listed suggest that the information needed to integrate ESG-requirements into the credit process is data, some of which is not yet available or the data source is still unknown. After defining the measures to include ESG in the credit process, the next step is therefore to analyze what data is needed to implement the measures as well as where and whether this data is already available in the system. Depending on the type of loan or even type of borrower, business or private customer, different data is also required. It is already clear that ESG-data must be incorporated not only into the credit strategy, but into the entire credit process and ultimately into the credit decision.
Our recommendation
Address ESG-issues and internal implementation status as promptly as possible and review what actions need to be taken to fully integrate ESG into your credit process.
We at ADWEKO are happy to support you in ESG-preparation and implementation as well as in determining your implementation needs and efforts.
talk to
Anchel Kalra!