Banking by Acronym: Financial institutions enter a new type of financial literacy

Heather Mosley | SBJ

 The banking industry is wrestling with a new equation these days, and it isn’t strictly about numbers. It’s centered on three letters: ESG.

Conversations among financial leaders worldwide are becoming sprinkled with the acronym. In longhand, it’s environmental, social and governance. And it’s ultimately setting guiding principles for banks to act fiscally responsible when it comes to those three segments. Think of it as a new type of financial literacy.

“In old school, traditional finance theory, it was all about maximizing shareholder value. In today’s world, that definition has been expanded to now maximizing stakeholder value,” said Jeff Jones, the finance and general business department head at Missouri State University. “That’s where your ESG factors come into play.”

Banks are applying ESG principles in everything from diversity in hiring policies to evaluating emissions impacts when lending to companies.

Corporate policies and practices surrounding environmental sustainability, social movements and ethical governance are nothing new. But for banks, particularly those publicly traded, Jones said ESG statements straddle two sides: shareholders and stakeholders.

“Companies are being required to address these issues in their 10-K reports,” Jones said of the annual report filed with the U.S. Securities and Exchange Commission on financial performance.

But the stakeholders involve bank customers, particularly commercial loan recipients and investors, employees and the communities where they do business. In other words, under these guidelines, banks are more attuned to where their money is going in the markets.

“It is becoming more and more important,” Jones said, noting the conversation among financial institutions “has been 20 years in the making” and is not a fad.

Early steps
Last year, two Missouri-based, publicly traded financial institutions – Commerce Bancshares Inc. (Nasdaq: CBSH) and UMB Financial Corp. (Nasdaq: UMBF) – issued ESG reports.

Commerce Bank President and CEO John Kemper noted in his introductory letter it was the bank’s first dedicated to ESG. Verbiage in the 40-page report fits the two-pronged description laid out by Jones.

“The report demonstrates how our approach to ESG management benefits our shareholders and at the same time delivers against the needs of our many other stakeholders, including our customers, team members and communities,” Kemper wrote. “ESG management is a journey, and we take seriously our responsibility to be part of the solution to the shared challenges we all face.”

ESG discussions in the financial world were punctuated last spring when a working group called the Net-Zero Banking Alliance was formed during meetings of the Sustainable Markets Initiative’s Financial Services Taskforce. According to organizers of the United Nations-convened alliance, the 43 signatory banks have grown to 106 members representing 40 countries and nearly 40% of global banking assets, with household names Bank of America, Deutsche Bank, Lloyds Banking Group and UBS as founders. In this case, the efforts are centered on emissions: aligning their lending and investment portfolios with net-zero emissions by 2030 for founding institutions and by 2050 for newcomers.

For its part, the U.S. Securities and Exchange Commission last year created the Climate and ESG Task Force. The 22-member group is tasked with identifying “any material gaps or misstatements in issuers’ disclosure of climate risks under existing rules” and analyzing “disclosure and compliance issues relating to investment advisers’ and funds’ ESG strategies.”

The SEC task force also is working to evaluate and pursue tips, referrals and whistleblower complaints on ESG-related issues.

The Commerce and UMB reports are sprinkled with ESG metrics: Commerce scored 90 out of 100 in the Human Rights Campaign Corporate Equality Index for LGBTQ equality in the workplace; 161,000 kilowatt hours were generated by solar panels on UMB properties; $2.3 million in philanthropic investments by the Commerce Bancshares Foundation; and 29% of UMB hires last year were people of color.

Local officials of area banks contacted for this story either did not respond or declined an interview, citing internal policy and limited information in individual markets.

The rate of adoption on the local level could depend on the oversight applied by bank regulators, Jones said. For instance, state-chartered banks would look for guidance from the Missouri Division of Finance and federally chartered banks follow the Office of the Comptroller of the Currency. 

“I think the push for publicly traded companies is really more at the SEC level,” Jones said.

Best practices
For banks in the early stages of the ESG journey, Jones suggests reviewing the materials from banks a couple steps ahead on the path.

“If I’m an institution, particularly small or midsize, I probably don’t need to reinvent the wheel,” he said, pointing to the coalescence already in the industry that can guide best practices. “There are probably some existing policies, resources, organizations from which I can begin to craft my own policy.”

And for the later adopters, he said it could become a competitive disadvantage in the marketplace.

“If there’s 10 banks on the street and you’re the only one that’s not part of this,” he hypothesized before acknowledging a competitive advantage for volunteer participants. “For some customers, absolutely that would be the case.”

Jones said he believes ESG will shape institutions for years to come. And MSU is teaching the concepts to business students now.

“It’s one of many considerations in terms of evaluating companies and, increasingly, evaluating customers,” he said. “From the perspective of a financial institution, you can have things your investors may want. But also because of the nature of customers and the lending function, you have to discern and may use ESG compliance as one measure.”

He compares those conversations with customers to bankers’ long-held Five Cs of credit: character, capacity, collateral, capital and conditions.

“To me, the biggest one of those is character,” he said. “What is the character of the person to whom you’re lending? So, that ESG piece, if you’re lending to a company, perhaps can give some insight into that.

“If you had a customer that was willing to do their part to help with environmental issues, or social or wage issues, probably a greater chance they’re going to be willing to pay you back.”