Sustainability and Banking

Financial Times and IFC have concluded their Sustainable Banking Awards for 2007. The winner all the way was ABN AMRO; winning in both; overall and the emerging markets category.

In the lead-up to the awards, FT provided an opportunity for readers to query Rachel Kyte, director of IFC’s Environment and Social Development Department, and Leo Johnson, co-founder of Sustainable Finance Ltd, the technical advisers for the FT Sustainable Banking Awards, on how banks are integrating environmental, social and corporate governance considerations into their business and the challenges ahead.

I have highlighted some of the questions and the responses below.

What is the biggest unrealised opportunity in sustainable banking?
Virender Singh, Delhi

Rachel Kyte: I think there are two. Finding the financial products that will value natural resources in situ and let communities sustainably harvest them or protect them. These will be forest bonds, commercial ecosytem payment schemes and water pricing instruments. We are very close – but the world’s natural infrastructure needs the same kinds of investment innovation as the world’s built infrastructure needs.

Second, finding ways to bring services to the poor – the next billion – not just microfinance, but services that let them create wealth through health insurance, life insurance and education funding. This is already beginning – but is a huge untapped opportunity for all

Can sustainable banking be delivered by a corporate culture driven by large city bonuses encourage employees to focus on short term individual goals, whereas sustainable objectives are usually long term and collective in nature?
Rev Patrick Gerard, Solihull

Leo Johnson: The glib answer is no. But is that about to change? TXU is an interesting case – 11 coal fired power plants fast-tracked for approval by the governor of Texas, Rick Perry. What happens? The allegation emerges that they are going to produce 78m tonnes of CO2 as the alleged footprint of the projects. The campaigns begin. The media, the banks, the NGOs. What happens next? Private equity steps up to the plate.

Texas Pacific, along with KKR make a $40bn plus proposal that is called the world’s first leveraged environmental buyout. In an all night meeting they convene TXU’s management and the leading NGOs and make the case that the only way for this company to succeed financially is to close down eight of the 11 and adopt good practice technologies for the remaining three. There is now a private equity counter bid based around the same sustainability strategy. That was private equity. That is the power of the bonus. If social and environmental externalities are starting to get internalised into the balance sheets, we will start seeing the most incentivised as the most powerful agents of change.

The recent forestry deal by Bank of America underscores the innovation in finance suggested by Rachel Kyte above. The financial industry has seen some amazing innovations over the past decades. Junk bonds revolutionized the leveraged-buy out mechanism in the US. The ability to package assets into bonds like mortgage backed securities provided new avenues of generating funds and transferring risk. Derivatives changed the way risk was hedged. Carbon trading is creating new opportunities to value forests and financial transactions like Joint Implementation as part of the Kyoto Protocol are helping to provide a low-cost method of decreasing carbon-di-oxide. Now in the same way a new wave of financial innovation in the environmental sector will fund the growing needs of sustainability.

As Leo Johnson suggests above; as externalities are being internalized it creates powerful new incentives to create change. Atanu Dey makes a powerful statement about incentives.

Incentives matter and just like you can explain all sorts of natural phenomena by understanding the law of gravitation, you can explain all sorts of diverse economic puzzles by asking what are the incentives.

One important learning for me is that as the economic structures change; sustainability is creating a new perspective/lens for business. A lens which creates innovation, opportunity and growth. A perspective which can literally create change.

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