Global warming, extreme weather, new diseases, social inequalities and biases, corporate scandals, and bad working conditions are just some of the issues disrupting the way we live. There's a worldwide call to radically address these and one of the first to respond was the financial sector led by banks, the money makers.
How can lenders address these issues, which are far from their usual duties of making money?
Banks have been incorporating environmental, social, and governance (ESG) metrics in how they make money as early as the 2000s. These were only underscored, however, when ESG issues grew bigger than initially imagined. In the Philippines, ESG metrics are relatively new and were only formalized in 2019 when the Securities and Exchange Commission required publicly listed companies (PLCs) to submit annual sustainability reports.
Banks are not environmentalists nor conservationists but as innovative institutions have crafted financial products with environmental goals. Local banks have been issuing green and sustainability bonds since 2017. These bonds are earmarked for funding environmental and sustainability projects involving renewable energy, sustainable agriculture and fisheries, clean transportation, sustainable water management, and cultivation of environmentally friendly technologies, among others, and also strengthen the capacity of ESG projects to be more impactful.
As pressure from climate activists escalate, banks are now slowly departing from funding coal-fired power projects. In 2020, Rizal Commercial Banking Corp. became the first in the Philippines to phase out funding for new coal-fired power projects. In April 2021, meanwhile, the Bank of the Philippine Islands announced its bid to move away from coal-fired power project financing in five years.
Overseas, in Europe and in the US, there's an increasing type of borrowing called sustainability-linked loans. According to recent Bloomberg Green data, sustainability-linked loans jumped to US$52 billion in volume in 2021 through May 21, a 292-percent increase compared with 2020 data. A sustainability-linked loan is a debt agreement with standard finance criteria but interest pricing is linked to key performance indicators (KPIs) that include various sustainability goals. If the borrower achieves agreed KPIs on water use management and energy efficiency, for example, the interest rates that the borrower needs to pay will go down. Otherwise, penalties may be levied or interest rates go up.
In contrast to green and sustainability bonds, sustainability-linked loans have no restriction on the usage of funds and hence is more inclusive to accommodate all kinds of borrowers. Unfortunately, this type of loan is not yet offered by local banks. In Circular 1085 issued in April 2020, the Bangko Sentral ng Pilipinas (BSP) gave local banks three years to fully transition to green (and sustainability) finance, which includes incentivizing loans for borrowers that adhere to environmental principles. This fuels hope that sustainability financing will finally knock off traditional financing, which is mainly focused on balance sheets and margins.
Bankers are not social scientists but are able to drive financial resources to address social issues and gaps in affordable housing, access to essential services (e.g., health, education, and financial services), food security, employment, and others. Banks have also issued social bonds designated for financing projects that address social issues and gaps. These bonds help boost micro, small and medium enterprises (MSMEs) and agriculture sector financing and expand financial reach to the unbanked.
According to latest Trade department data, 99.5 percent of businesses in the Philippines are MSMEs, which also account for 62.4 percent of total employment. Infusing fresh capital to MSMEs and the agricultural sector means cultivating businesses that support over half of total employment in the country, which leads to improvements in quality of life and food security.
Despite the immense potential to drive inclusive growth, however, MSMEs and the agricultural sector are less likely to apply for and get approved financing in the Philippines due to the lack of collateral and credit history, inadequate documentary requirements, and perceived slow turnaround of loan applications. Banks have entrenched perceptions that serving MSMEs and the agricultural sector is a high-cost, high-risk but low margin undertaking. Given this, banks veer away from investing in internal capacity, tools, and market research to serve this market viably and strategically without relying on the use of collateral.
The BSP has recognized these challenges and is currently undertaking initiatives to bridge banks and MSMEs by partnering with the Japan International Cooperation Agency to initiate the Credit Risk Database (CRD). The CRD is an alternative source of credit information that lenders can use to assess MSME borrowers' capacity to pay using statistical credit scoring models. It aims to promote risk-based lending, lessen the dependence on collateral during credit evaluations, and improve access to finance. By providing a robust credit assessment tool, the CRD can address key MSME financing challenges that arise from the lack of collateral or thin credit histories as well as banks' lack of information to support credit assessment.
The BSP also supports the capacity building of credit surety fund cooperatives, a credit enhancement tool that provides a maximum 80-percent surety cover for loans granted by banks to MSMEs that typically experience difficulties accessing credit. The Standard Business Loan Application (SBLA) was initiated in 2020 to introduce the adoption of SBLA documents in the banking industry to make loan application processes more streamlined and borrower-friendly, particularly for MSMEs.
By partnering with the Asian Development Bank, the BSP also supports the development of agriculture value chain finance (AVCF) to facilitate the financial inclusion of small farmers and agricultural MSMEs as well as support and catalyze growth of export-oriented agri-value chains. The AVCF is an information-based lending approach that uses acquired information and understanding of the value chain process to adequately assess lending risks.
Gone are the days that corporate boards at the top of high-rises were closed off to issues outside the balance sheet. Increasing demand for transparency has prompted boards to discuss genuine fiduciary relationships with stakeholders, shareholder engagement, and employee diversity and equity. Banks and other corporates have realized that ignoring externalities has significant financial impacts. That is why there is a common narrative that bank failures during the financial crisis reflected poor corporate governance.
Boards are now paying extra attention to all conflicts of interests and transparency of operations. With the help of regulators, corporate governance is one of the required disclosures in the annual reports of PLCs. This allows the investing public to see, read, and judge a corporation's true performance beyond numbers.
The whole concept of ESG may sound like a PR spin, since reputation is everything, but we cannot dismiss the moral shift on how we imagine banking in a post-pandemic world.
As published in The Manila Times, dated 18 August 2021
