Don’t let precision get in the way of action on sustainability

WWF-Singapore’s sustainable banking assessment report has found progress among ASEAN banks on sustainability. In particular, there has been progress in setting the broad direction and starting on implementation. Much less progress has been made to date on impact through client engagement, portfolio decarbonization targets, and disclosures. The best way to make progress on underlying data gaps is to focus on tools to incrementally improve accuracy, rather than waiting too long for precision.

  • ASEAN banks have made noticeable improvements in making public statements on sustainability and starting implementation such as through narrow sustainability-related exclusions
  • Banks still need to make more progress in showing how their actions relate to environmental & social impact in the real economy as their policies influence customers’ behavior
  • Disclosure is an important demonstration of progress, but incremental improvements in the data and analytics that banks themselves use are preconditions for better disclosures and require action based on improving accuracy over time, not waiting for precise data before acting

There are encouraging trends in the latest Sustainable Banking Assessment for ASEAN-based banks according to a recently released update covering banks’ 2021 disclosures. Banks in Malaysia and Indonesia each progressed, particularly in statements and stakeholder engagement on sustainability, and setting some policies around particular sectors and environmental & social (E&S) targets.

At the same time, with regard to the most critical elements of promoting sustainability outcomes, there were still gaps in formal and broad escalation policies driven by E&S changes. WWF-Singapore, who authored the report, noted that “banks need to fine-tune their E&S policies and processes to ensure they are having a material impact on the ground towards transitioning to a sustainable future and that this impact is attributable to their specific actions”.

On few issues would this call-to-action be more important than those related to climate change, where timing and durability of actions are essential. The review assesses banks along a four-point progression in comparison to international banks selected as ‘best practice’ examples. The stages were defined by the actions needed at that stage, from “Acknowledge” at the earliest point through to “Implementation”, “Increase impact” and “Achieve sustainable future”.

The first two phases are where Indonesia and Malaysia had progressed the furthest among the 8 and 6 banks, respectively, that were reviewed by WWF-Singapore. The final two were much more varied between the two countries’ banks and among different banks in each country.

The RFI Foundation has consistently highlighted challenges once implementation begins on responsible finance. It’s an important step to build institution-wide buy-in for the efforts on responsible finance, and to support it throughout a bank with a robust policy. But because sustainability, ESG or even individual issues like climate change do not have single metrics for each sector that operates independently, action takes time.

Sector exclusions — such as for coal-fired power plants, which 45% of banks across the 8 countries covered in the SUSBA Insights Report 2021 had adopted — fall into the “Implementation” stage and need to be further built upon because efforts taken will affect other sectors, and successful implementation needs to be based on evaluation that stretches well past the coal-fired power sector or energy industry.

The real economy impact of policies on coal exclusion and ways that other financing activities can support their implementation is harder to address than the first step of adopting a policy moving away from coal finance. It further reinforces the need for financial institutions to make their decisions based on analysis that highlights the connection between their decision and the broader economy’s ability to move onto a durable path to meeting national targets in line with global ambitions for achieving the Paris Agreement targets or longer-term Net Zero objectives.

A simple example I like to use is that all the electricity produced is consumed somewhere, and the demand for electricity is growing year-over-year. If there’s 30 TWh demand today and that amount grows 5% annually, then next year there will need to be 31.5 TWh produced to meet demand. Adding production capacity that will generate 1.5 TWh in that same period (the amount generated in Malaysia in 2021) will only meet the growth of demand; it won’t reduce the amount of power generated through non-renewable sources.

That means, if a bank is looking at its financing portfolio to determine if it’s aligned with the path towards a low-carbon economy, they’ll see just a small portion of their portfolio able to finance new solar power, for example. With energy prices rising sharply, a bank may also see constraints in how much it can accelerate the pace of phasing out financing of coal power.

However, the 1.5 TWh of electricity demand growth provides a window into opportunities for a bank to use more of its financing portfolio to create real economy impact than just narrow sector-focused initiatives. For example, by focusing on linkages between electricity demand growth in other sectors (even those that are relatively smaller contributors to electricity demand growth), the impact of the solar generation financed by the bank can shift, kilowatt-hour by kilowatt-hour, to meeting new power needs into reducing demand for non-renewably sources of electricity.

Currently this type of analysis is hard to do on a wide scale because data isn’t available. to make the linkage. Even a linkage as conceptually clear between the electricity demand changes of a banks’ customers and the financing it directs to renewable sources of electricity is hard to evaluate on a portfolio-wide basis. Waiting until reliable data are produced will delay action far too long for too little to be gained in terms of accuracy.

This is the type of action that is needed by banks in Malaysia and Indonesia and beyond. With the data gaps that exist, it’s not merely the perfect being made the enemy of the good. It’s precision with the data that can be created and used today set against accuracy needed to make progress on critical sustainability issues. With time the data used and analytical tools developed will improve, but this should not be seen as an obstacle to action because neither data nor tools will develop except in response to taking action and finding specific gaps that need to be addressed or resources to be improved.

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Promoting adoption of responsible finance in Islamic markets & Islamic finance. CEO @RFIFoundation.

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Blake Goud

Promoting adoption of responsible finance in Islamic markets & Islamic finance. CEO @RFIFoundation.