Commercial lending and sustainability
Example of:
How banks can provide practical support to their credit risk and client facing teams to help them better understand the sustainability risks associated with commercial transactions.
Why should sustainability within lending be considered?
- There is a growing reputation risk regarding who you lend to or the types of activities you finance.
- Agreed practice is continually being developed within the sector (e.g. Equator Principles for Project Finance).
- It provides an opportunity to improve the outcome of lending decisions.
How Barclays is embedding sustainability into its lending decisions
Who needs support?
Client facing and credit risk teams need to understand the potential sustainability risks that relate to clients and the sectors in which they operate. They, along with other interested parties such as legal, require on-going sustainability training and/or awareness raising to ensure they are able to make a judgement on the level of sustainability risk associated with a particular client or transaction.
In our company, credit and business teams gain knowledge through practical experience, reference to sector specific information and reference to sustainability experts within the company for specialist advice as and when necessary.
How to support?
In assessing sustainability risks, teams involved in commercial transactions will consider a number of factors including the following.
- Where is most of your money lent?
- Which sectors are you working with? Do they have a good or bad reputation on environment, safety, human rights performance?
- What is the market overview?
- In which countries do you operate? What are the risks in those locations (consider social, economic, reputation and environmental risks)? What regulatory frameworks exist in those countries?
- Who are your customers and what are their key risks?
- How do you assess social or environmental risk? What weight do you put to these risks, how do you manage any issues? When do you say no?
- Who within the organisation needs to manage these risks? What support do they need?
- What is the quality of the client and their capabilities - including: quality of management team, cash flows, business plan, how well do they manage their own risks? What capacity do they have to manage sustainability risks? What commitment do they have?
Commitment of the client is more important than capacity as the latter can be built over time if there is the commitment to do so.
To factor sustainability within these decisions individuals or teams must be aware of potential risks, know what to look out for or have a process they can follow to deliver the right outcome. Generally there are two approaches that banks currently take.
Guidance based approach
Teams or individuals are coached on the importance of factoring sustainability risks into transactions and encouraged to make use of sector or issue specific guidance. Sector guidance could focus on high risk sectors such as energy, mining, forestry or transportation; issue guidance could focus on priority risk areas such as climate change, palm oil, human rights or water quality.
The purpose of guidance is to encourage individuals to think independently, providing information that can be used alongside existing knowledge and experience of the decision maker. Sector specific guidance could include the following information.
- How to identify ‘no go’ areas – i.e. who will you not lend to?
- Identification of where you will draw the line, for example will you work with clients who do not meet agreed international standards on the proviso that they demonstrate a commitment to reach them and are willing to report on progress over time.
- Identification of relevant external standards that should be followed, for example the International Finance Corporation Performance Standards, Environmental Health and Safety Guidelines, the World Commission on Dams Framework and so on.
- Brief descriptions of relevant risks covering social, environmental, reputational and governance aspects.
One criticism of guidance is that there is no guarantee of consistent application, which may not be acceptable to some of your stakeholders.
Policy based approach
This approach will have greater governance and teams will be mandated to make use of polices and tools. This runs the risk that individuals will follow a ‘tick box’ approach but allows for greater standardisation and monitoring of decision making. The benefit for most financial organisations is that once it is policy it must be done.
In our company, ‘policy’ comes with a number of governance issues such as policies need to be reviewed annually, which can generate considerable workload.
When drafting policies you will need to engage with employees directly involved in the business for example, client facing staff, project financiers and so on to agree a sensible approach on how you will deliver the policy. Once drafted, you should consult with external experts, including relevant industry bodies and clients themselves. It can also be helpful to consult with interested NGOs as they often have great technical expertise.
How Barclays is embedding sustainability into its lending decisions
At our Bank, new lending prospects are developed by various business teams across the bank. Any transactions that they wish to progress must be passed to our credit risk team to undergo a process of credit review. Funds cannot be released without credit approval. The business teams therefore involve the credit risk team early in the process.
The credit risk team review the entire transaction including legal, credit, social, environmental and due diligence aspects. They consider direct, indirect and reputation risks. Teams work together to structure the deal appropriately before a final decision is made by credit committee. The bank is guided by a ‘do no harm’ philosophy and aims to ensure that no material losses are incurred.
The main role of the central environment team is to ensure each credit risk team has sufficient knowledge of social and environmental risks to enable them to make a final decision locally without having to refer to the central environmental team for advice. Increased awareness is achieved through an ongoing process of knowledge transfer incorporating workshops, presentations and ad hoc information provision (for example, tracking current media interest in particular projects). Business, credit risk, syndication and legal teams are invited to attend events at the same time to promote a common understanding of issues (any other interested parties can also attend). In addition, there are a number of environmental champions who can act as communication channels and help to cascade relevant information locally.
In its coaching role, the central environment team works to ensure credit risk teams are kept up to date on social and environmental issues that are relevant for the business (for example, key issues or sector specific information). More detailed support is provided in guidance notes, which address over 50 environmentally sensitive sectors and are made available on the Bank’s intranet along with the environmental and social impact assessment (ESIA) policy through which the Bank applies the Equator Principles.
By enabling credit risk teams to understand and make most decisions themselves, the central environment team can focus their attention on the larger scale or more complex decisions. Referrals to the central environment team occur when the credit risk teams feel they need additional advice on particular social and environmental aspects of a deal. External specialist advice can also be sought. If the deal is particularly large, or is likely to attract NGO or media attention, it may also be referred to a senior management committee, either at a business or Group level, before a decision can be reached.
Assessing the significance of social and environmental risks is a skill which is acquired over time through practical experience. A prescriptive approach is not encouraged as social and environmental issues can be complex and wide-ranging. The central environment team want decision-makers to take a flexible approach, appropriate to each circumstance. They are encouraged to think as broadly as possible when considering the risk profile of a deal – a check list of issues would not support this approach.
The Bank believes it benefits from its enlightened approach to assessing social and environmental risks. A greater understanding of potential risks helps to minimise the time taken to reach a decision; avoiding lengthy review processes (which can take months or even years on large deals) for deals that may ultimately be declined. The knowledge obtained can also help the Bank to avoid becoming involved in controversial deals which may have associated financial and reputation risks.