In Confusing Times, Clarifying ESG principles is Key for the Region’s Banking Sector

Recent global political and financial tensions highlight the importance of environmental, social, and governance (ESG) factors for the region’s banking sector. A study provides key conclusions on the early adoption of these factors in the Southern Cone.

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Global political and financial tensions have highlighted the importance of environmental, social, and governance (ESG) factors in investment and lending decisions. A recent study provides key conclusions on the early adoption of these factors by Latin America and the Caribbean’s banking sector.

ESG factors have long been considered as something desirable, although not urgent, but current global events have made it clear that we have entered a different phase. The issue of whether, for example, it is acceptable to invest in certain energy projects or the manufacture of weapons has given rise to heated discussion. Even Elon Musk, one of the world’s richest people, has waded into the debate.

As such, it is important to fully understand where we are in the region in terms of the adoption of ESG factors, the level of acceptance among financial institutions, how these factors are understood in a general sense, and how they are applied specifically.

Banks are especially important stakeholders in this issue for several reasons. Firstly, their role as intermediaries between investors and savers makes them relevant players in channeling funds toward activities that have social and environmental impacts. On the other hand, the banking sector faces risks due to climate change, including transitions associated with shifts in environmental policy, reputational impacts, technological innovations, and changes in market preferences and social norms.

This article summarizes the main results of the sustainability survey that we have conducted, first with (public and private) Uruguayan banks. The sample included the country’s main public bank and six private banks, which together represent the majority of Uruguay’s financial system (more than 90% of deposits).

It is important to keep in mind that IDB Invest has already conducted this survey three times in Argentina and will implement it in other countries in the region, which will enable us to compare results, and that Uruguay is at an earlier stage in the development of sustainable finance than its peers in the Southern Cone (Argentina, Paraguay, and even Brazil).

Uruguayan banks have made significant progress in their awareness of this issue and the Equator Principles (86%), the ESG benchmark for the region’s financial institutions. However, only 29% of institutions have already adopted these principles, above the 10% reported by Argentine banks the first time we conducted the survey, and greater understanding is necessary for their adoption.

As in other countries in the region, one interesting conclusion has emerged regarding the application of sustainability criteria by banks: 57% of respondents agree that some minimum criteria should be mandatory, while 29% said that sustainability policies should be advocated and promoted by the regulator, but not imposed compulsorily.

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Similarly, indicative of their interest, the majority of Uruguayan banks (71%) has already formed a team to oversee ESG issues. However, these teams are multi-disciplinary with little specific ESG experience. Banks in the country have started to apply exclusion lists, but with little homogeneity, and the use of ESG risk management systems is not widespread.

With regard to the inclusion of ESG aspects in operational analysis, Uruguayan banks are currently behind their regional peers. 57% of respondents said that they are currently evaluating ESG criteria or have taken them into account in some of their operations. However, 71% of respondents do not define ESG criteria upon granting loans, and only 43% have fully adopted a written environmental and social risk analysis policy.

In view of the above, we can conclude that Uruguayan banks have made significant progress on ESG risk management in their internal operations, with sustainable supply chain management standing out in some cases. However, this progress is not reflected in their loan portfolio management, which represents both a major opportunity and a necessity for banks to support the financing needs of this decade. Are we on the right track? Yes, of course.

Even though 57% of banks said that they publish sustainability reports, none of these reports include a taxonomy of their loan portfolio or a classification of the various commercial products offered (green, social, or sustainable) with their corresponding ESG risk management or contribution to Sustainable Development Goals (SDGs). Not all banks keep a record of loans granted that are related to ESG issues, and a clear taxonomy of the loan portfolio has only been detected in a single case.

We can conclude that joining forces and standardizing criteria are the most urgent steps for the development of sustainable finance in Uruguay. Public investment alone cannot achieve these goals. For that reason, promoting a sustainable finance roadmap is key, and now is a great moment for the country to do this.

The recently launched Public-Private Sustainable Finance Roundtable, which brings together public and private-sectors players, will contribute to this goal by galvanizing the industry as a whole to take action on ESG issues. Along the same lines, the country’s efforts to develop a sovereign SLB complement and strengthen the mainstreaming of climate policy, as well as sending a signal to all financial institutions. There is even support from academia, with the University of the Republic’s Faculty of Economics and Administration incorporating a Sustainable Finance Unit in its Master of Finance program.

 

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Authors

Matilde Peñagaricano

Matilde is Investment Officer in Financial Institutions at IDB Invest, where she joined in 2017. Matilde is responsible for the relationship with the

Margarita Roldós

Mauro de la Vega

Gender

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