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Pushing its way on to boardroom agendas

By Patrick Jenkins, Financial Times

02-06-2010 | Sustainable forestry, sustainable fishing, sustainable farming - the idea of managing the earth's natural resources in a prudent way has been gaining ground rapidly in recent years, as the world realises that failing to do so could destroy us all.

Now, so the optimists of the world's financial markets believe, there is a unique opportunity to make sustainability an integral part of banking.

Eighteen months on from the depths of the 2008 financial crisis - and with fears of a European sovereign debt blow-up mounting - the concept of sustainable banking is moving into the mainstream.

For decades, sustainable banking has been making gradual inroads - underpinning banks' commitment to environmental issues, charitable giving and the like. The entries for this year's Sustainable Banking awards - co-sponsored by the Financial Times and the International Finance Corporation - have seen mainstream banks, such as HSBC and Brazil's Ita├║ Unibanco, shortlisted alongside established ethical brands such as the Co-operative Bank.

Lars Thunell, chief executive of the IFC, says: "Environmental and social concerns are being taken seriously by financial institutions globally, and this year's entries underscore how institutions are incorporating sustainable financing into their operating decisions."

Royal Bank of Scotland, which recently published what it believes is the most detailed sustainability report of any bank, has stepped up its focus on the area, as it retrenches from high-risk activity. It recently created a board-level sustainability committee to push the issues at the highest level.

Andrew Cave, head of corporate sustainability at the bank, says one early example of progress is that employee diversity - with regard to gender and ethnic origin - has now made it on to the agenda of the board.

There is also a renewed push, says Mr Cave, to extend the so-called Equator Principles, which since 2003 have provided a global blueprint, under the auspices of the IFC, for the social and environmental standards required for banks' project finance work.

Many of the world's biggest 15 banks now want the voluntary standards extended to corporate finance.

But if some mainstream banks are taking sustainable banking in its narrow definition seriously, that is only part of the story. For some at least, especially among those hardest hit by the financial crisis, there has been a sharpened focus on the more general sustainability of their way of doing business.

Along with many banks that blew up in the crisis - from Northern Rock in the UK to IKB in Germany to Lehman Brothers in the US - RBS had sought to expand at unsustainable rates.

But with 70 per cent of its shares in the hands of the UK government after a bail-out, RBS, under the leadership of chief executive Stephen Hester, is well aware that sustainability must become a broad defining principle.

Mr Cave says: "We are fully signed-up to the goal of sustainable, long-term banking. That means providing customers with useful products that deliver an acceptable return for RBS, but with a view to social and economic responsibility, too."

That was hardly the general attitude in the years running up to 2007. By investing in complex derivatives and borrowing at an unprecedented pace in international markets, many successful banks generated profits, as measured by return on equity, that outstripped nearly every other sector - to the delight of investors.

But as the crisis proved, generating ROE of 25 or 30 per cent was just storing up trouble.
Triodos, the Dutch group that has been a flagship of ethical banking for 30 years, thinks its 7 per cent ROE is the kind of figure that other banks should aim for - "our pension fund investors are quite happy with that, it's like a bond with a little bit of upside", says Peter Blom, chief executive.

Mr Blom's big beef is that bank profits should basically grow in line with GDP. "The world has been pushing bank shares and expecting banks to grow far faster than the economies they are designed to support. That is what is not sustainable."

The idea of stripping banking back to its basic role - of "serving the real economy rather than taking from the real economy", as Mr Blom puts it - is one that has gained considerable support in the wake of the financial crisis and the subsequent government bail-outs.

In a famous excoriation of the banking sector last summer, Lord Turner, chairman of UK regulator the Financial Services Authority, said the sector had "swollen beyond its socially useful size".

Certain products - many derivatives, in particular - appeared to play no useful social role, he said.

The global debate that has ensued is simple but profound, highlighting the tension between the social and economic function that the world wants banks to fulfil - whether that be in the form of microfinance in emerging markets or large-scale lending to big business - and the allure of more obscure, higher-profit activity.

"The socially useful stuff," says Michael Raffan, partner at lawyers Freshfields Bruckhaus Deringer, "tends to be low-margin".

Undeterred, regulators and policymakers are poised to make deep-seated reforms to the potential profit of high-risk activity - by forcing banks to hold more capital and liquid funds, and imposing new bank taxes - as well as overhauling the structure of the sector.
In the US, President Barack Obama may yet force through a significant clampdown on the riskiest Wall Street activities, despite stiff Republican opposition.

In the UK, the coalition government led by Prime Minister David Cameron of the Conservatives, and his deputy Nick Clegg, of the Liberal Democrats, has promised root-and-branch reform of the structure of banking.

Big universal banks, embracing retail banking and higher-risk investment banking, could be broken up. Some analysts have predicted that if all the initiatives under consideration were implemented, ROE could fall below 10 per cent.

All the while, politicians on both sides of the Atlantic have latched on to one of the core principles of sustainable banking - that banks should be basic providers of reasonably priced credit to the economy, and especially to small businesses, particularly in sectors such as renewable energy and food production that are essential to the long-term health of the planet.

With governments in countries from Germany and the UK to Ireland and the US at least part-owners of big banks, politicians feel they have a unique opportunity to ensure the "social usefulness" Lord Turner spoke of is put into practice.

Over the past year, bank lending targets set by governments have been missed, but bankers insist that there are technical reasons for this and that their underlying principles have changed.

So far, that claim has struck no chord with the broader population.

"How are banks going to respond to their pariah status?" asks Mr Raffan. "They've got a good story to tell, but they haven't been as effective at lobbying as they could have been."

Quite how good the story is, some doubt - at least when it comes to hard-core sustainable values in the short term.

For every example of forward thinking - witness Bank of America Merrill Lynch's new high-technology, high-efficiency headquarters in Manhattan - there are discouraging trends, such as RBS's move away from renewable energy financing, as it shrinks its bloated balance sheet.

"Before the financial crisis," says Triodos's Mr Blom, "mainstream banking was looking at sustainable banking quite seriously.

"But the crisis has brought many banks back to existential questions and they haven't had time to think about ethics."

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