Banks need to raise their game in battle against deforestation
posted by Tom Bregman, 12 April 2019
Despite financial institutions becoming increasingly aware of the environmental and social impacts associated with deforestation, more than US$235 billion, or 58%, of identified loans to Forest 500 companies are still not covered by sustainable lending policies.
Financial institutions, including banks, can play a key role in encouraging companies to develop and implement sustainable production and procurement strategies. For example, they can require companies to meet sustainability criteria to access credit, and regularly engage them to encourage the production or procurement of sustainably produced commodities.
Loans to companies that operate unsustainably expose banks to reputational risks. Unsustainable business models can also damage a company’s profitability, which may impact its ability to repay loans. For example, companies may not be able to sell their products to manufacturers and retailers with zero deforestation policies, potentially limiting their company revenues.
Banks with sustainability policies need to ensure their clients comply with these policies
Global Canopy’s latest Forest 500 assessment of the robustness of financial institution policies reveals significant gaps in bank action on commodity-driven deforestation. In total, we estimate that 98 banks in the Forest 500 loaned $406 billion to upstream companies (producers, processors, and traders) in commodity supply chains. Of this total, only 42% was covered by a sustainable lending policy. And only 45% of banks had a sustainable lending policy in 2018 that was relevant to at least one of four commodities driving the majority of deforestation: palm oil, soy, cattle, and timber.
However, our research suggests that even where banks had policies in place, a number of the companies that they were lending to failed to match the commitments for the commodities that they were exposed to.
Using financial data from Thomson Reuters and Bloomberg, and information on bank and company policies from the Forest 500, we were able to assess the degree to which companies have policies that match those of the banks providing them loans. Banks with policies provided US$62 billion of loans, over 15% of the total, to companies without matching commitments in place.
This gap in bank sustainable lending policies is particularly extreme for certain commodities, notably cattle and soy. Of the $191 billion of financing to companies in cattle and soy supply chains, 78% was not covered by sustainable lending policies (orange and red bars in figure 1). Of particular concern is the $115 billion of loans that were not covered by either a bank or company policy.
What can banks do to better manage their risk exposure?
Firstly, it is essential that banks put in place sustainable lending policies for all commodities associated with environmental and social impacts. These policies should require the recipient companies to develop, implement, and report on sustainable production and procurement strategies. Detailed expectations to inform engagement between banks and companies can be found in the guidance document produced by Global Canopy/CDP.
Secondly, banks need to actively monitor, and engage, the companies that they are financing to ensure that they meet sustainability requirements and are making progress towards achieving their own commitments. The Portfolio Risk Tool hosted on SCRIPT (Soft Commodity Risk Platform available at www.script.finance) supports banks to identify and engage companies exposed to deforestation but not doing enough to mitigate the associated risks..
Finally, by publicly communicating the importance of transforming soft commodity supply chains to be more sustainable and the steps they themselves are taking, banks can send an important message to companies that unsustainable practices will no longer be tolerated.