What is the link between Socio-Environmental Development and Green Banking?
August 2022
Aminul Haque, Sona Analytics
Relationships between people and their environments are mutually influential: not only do people have an impact on place, but place also impacts the lives of its inhabitants. Considering both society and environment together is therefore an important part of ensuring a sustainable future not only for our planet, but also for its resident humanity – which is the goal of socio-environmental development.
However, while attention is increasingly focused on what governments and humanitarian organisations can do to encourage this, there has been little talk on the part that the financial world has to play. Here we take a closer look at why socio-environmental development is such a crucial effort, as well as why banks need to get behind it without delay.
Over the past few years, it has become ever more obvious that human beings are not just the primary causes of climate change, but also its self-made victims. Gone are the days when many, contrary to the warnings of the few, thought that leaking billions of tonnes of carbon dioxide into the atmosphere would have no serious negative consequences for society.
Recent research, shows that global poverty is growing in direct connection with our suffering environment. In 2018, the United Nations Development Programme stated that ‘over 2 billion, one third of the total population, are poor or near poor’, their homes and livelihoods threatened – or lost – by the effects of climate change.
The UNDP also estimates that climate change could force over 100 million people into extreme poverty by 2030, and that another 200 million could be displaced because of increasingly frequent and severe climate disasters.[1] These predictions highlight the absolute necessity of a comprehensive shift in behaviour towards more sustainable business operations and practices on a global scale, with the goal of reducing these detrimental climate effects and their impact on less developed, more vulnerable countries in particular.
But what needs to happen to achieve this? And how do sustainability analytics and a sustainability credit score system fit in this equation? The COP26 summit in Glasgow has emphasised that global recovery from the Coronavirus pandemic provides an historic opportunity to tackle both climate change and social challenges at the same time.[2] The universal effects of the pandemic on every industry have made rethinking and readjustment essential, rather than optional, so it is an ideal time to build back businesses with greener policies and practices. Not only will this contribute to a healthier planet, but it will also result in the creation of good jobs, thus providing a multi-faceted approach to socio-environmental progress.
Recent history shows that this is more than an idealistic notion: within the last thirty years, British governments have grown the economy by 78% while reducing carbon emissions by 44%. In addition, 40% of electricity was generated from coal in 2012, whereas that figure has now dropped to less than 2%.[3] These statistics prove that there are viable, sustainable options to promote green growth, tackle climate change and reduce its impacts on global populations.
For this to become reality, however, it is important that banks recognise and accept their share of the responsibility by focusing their investments on sustainable projects and businesses, which in turn will lead to positive outcomes for the planet and its people. In determining their lending practices, commercial banks rely on credit score systems that are developed to estimate the risk of borrowers being unable to make the required payments on their debt obligation. Banks usually rely on creditworthiness as the main criteria for their investment decisions, with all intelligence related to financial information or qualitative data.
However, it is essential that banks also begin to take companies’ attitudes and approaches to climate change into account so that they can distinguish between sustainable and harmful initiatives.
The Sona Sustainability Credit Score System (SSCSS) has been developed to facilitate this by giving lenders visibility into companies’ environmental policies and practices. It enables companies to be differentiated based on their sustainability rating, providing a factor for banks to decide whether or not to provide them with credit.
Companies are rated in the same way as in regular credit models, with sustainability worthiness ranging from triple A (prime borrowers) to D (default). If a company has a sustainability rating below investment grade (usually in the BB range or lower), it may mean increased interest rates or denial of credit, even if the company is otherwise creditworthy. Conversely, companies with high sustainability ratings may receive preferential treatment, either in terms of costs or access to capital.[4]
Assessment of their socio-environmental practices is included among the system’s indicators and could become a decisive influencing factor among investors, thus helping to define a better future not only for the planet, but also for its people.
[1] Kishan Khoday and Walid Ali. ‘Climate Change and the Rise of Poverty.’ United Nations Development Programme, 19 December 2018. Accessed 7 July 2022. https://www.undp.org/blog/climate-change-and-rise-poverty.
[2] UN Climate Change Conference UK 2021. ‘COP26 Explained.’ UN Climate Change Conference UK 2021, n.d. Accessed 7 July 2022. https://ukcop26.org/wp-content/uploads/2021/07/COP26-Explained.pdf.
[3] Ibid.
[4] Rodrigo Zeidan, Claudio Boechat and Angela Fleury. ‘Developing a Sustainability Credit Score System.’ Journal of Business Ethics, Vol. 127, No. 2, March 2014. Accessed 7 July. https://www.researchgate.net/publication/259634272_Developing_a_Sustainability_Credit_Score_System.
Keywords: sustainability; risk management; ESG; firm valuation; WACC; sustainable finance; scenarios; sustainability analytics; sustainability credit score system; Sustainable investing; sustainable analytics; analysing sustainability; Green Banking.