ESG Risk of Banking Sector
I visited a big branch of ICICI Bank at Delhi-NCR sometimes back. I found "5S" policy hanging in a clip placed in an isolated corner at bank, with lot of dust on it. In reality, policy is there but practice is missing. This is not the story of ICICI Bank alone. The condition of government sector banks are more poor and worst. One can't expect a systematic culture of "5S" here. You ask director level people sitting here in bank about the "5S". They start looking here and there! They try to skip their face! They try to avoid this question! This is skill gap. Hardly they know that regular practice of "5S" eliminates ESG risk. One beginner level example I can cite here. The second "S" principle in "5S", puts a mandatory environment to place tool, equipment, instrument in a properly yellow marked defined area. You can't change the location of equipment. Now imagine, fire has broken out in this bank. Employees are running here and there. The "fire extinguisher" is missing. It has no defined "Right Location". Yesterday it was near gate! Day before yesterday, it was inside the toilet! Bank is treating this equipment like an orphan tool. Bank burnt with fire. Is it not an ESG issue? Yes, this is a high risk ESG issue, required by Social Auditor, to identify and put on the audit report as ESG Gap.
The ESG risk identification during the ESG Audit in banking sectors are challenging issues. It needs strong knowledge of environmental law, human resource management practice & labor law, ESG & sustainable practices knowledge. The "5S" is a deep rooted ESG & sustainable practice, which not only eliminates waste but reduces to a larger degree high rated risk. The "5S" has never been sold by the Japanese or the South Korean. They treated it just like best business practices. But commercial America, sold this product in the name of "Agile". This is an old wine in a new bottle. It originated in Toyota business practice, but the South Korean actually implemented it in aggressive way. The HR head of a South Korean company has an inherent responsibility to develop "5S" culture inside the company. This culture is seen missing from the Indian, American and European companies.
Some Issues In Banking ESG :
The Paris Agreement, Article 2(1) letter (c), has major focus on the banking sector, involving finance flows, which consistently moves towards the low greenhouse gas emissions and climate-resilient development. This is challenging issues for the risk identification during the ESG Audit in banks. European Banking Authority in 2020, stated, that “most international frameworks and standards have refrained from establishing a single definition of ESG factors. While there is general agreement that ESG factors represent the main three pillars of sustainability, the lack of a single definition of ESG factors complicates its understanding and management in a consistent way”.
Shafik, N. in 2018 demonstrated that the social dimension of sustainable investment, has considerable impact. Any attempt to remove social exclusion is a real danger in managing the ESG. Now the “S” visibility in the ESG is widely increased in geometrical rate after the Covid pandemic effect. O’Connor, C. and S. Labowitz in 2017 demonstrated that, in measuring ESG what is “most convenient” should be replaced with the “most meaningful”. For this they studied, the impact of only two pillars, the ES and placed the “G” pillar isolated. They found, that in ES pillar, environmental issue has top priority as it was "most convenient" to implement and the social pillar has least consideration, as it was difficult to implement. Thus the "most meaningful" practice was missing. Such poor practice, increased the "high risk ESG issues", where E & S pillars are not properly balanced.
A study by the NYU Stern Center for Business and Human Rights, reviewed reporting in relation to the “S” pillar and concluded that the measurement of “S” usually focused on what was “most convenient” as against what were “most meaningful” and that “S” measures were often “vague”. Consequently, measuring “S” is unlikely to yield the information needed to facilitate the banking risks.
Stranded Assets of Banks:
In bank, the stranded assets are very poorly audited. In ESG risk, the stranded assets are little attended subject. This is either the lack of knowledge or skill. Assets in affected sectors, such as the oil and gas sector, may lose value to become “stranded”. The International Energy Agency (IEA) provides a definition of stranded assets from an ESG Audit point of view. This says to identify "stranded" investments that have already been released by banks but which, at some time prior to the end of their economic life, are no longer able to earn an economic return as a result of changes in the market and regulatory environment brought about by change in climate policy or ESG factor.
Some four sources of stranded assets have been identified. The first is related to abandoned carbon, since, if temperature targets are met, a part of fossil fuel reserves is not to be extracted. Another best example of "stranded asset" comes from Covid pandemic. Bank released investment, but are no longer able to earn an economic return as a result of declaration of moratorium period or loan seeker unable to pay to the banks due to pandemic situation. Second source is related to abandoned capital, since some investments in the fossil fuel industry will become obsolete once the economy switches to renewable energy. The other two sources are related to anticipated and realized stranded assets. The "anticipated stranded assets" example is the prices of fossil fuel assets, which may adjust long before the climate policy is enacted affecting the valuation of these assets. The "realized stranded assets" example is policy changes that are not anticipated with certainty and there is doubt about their actual implementation. But all these are major vital risk of the ESG.
The priorities reported by participating entities in a survey of practices prepared by the European Commission has enumerated many ESG Risk. For example, in "E" pillar, risk related to high sea level due to climate change has been given least priority in India.
All these escaped ESG risk, appear in "Other" column in the BRSR format. High sea level due to climate change, which appears in European Commission standard is that risk, which has potential to damage the banking business situated in sea coastal area. Mumbai town, is vulnerable site from the threat of high sea level. It has potential of damaging the banking business. If banking buildings are damaged due to high storm or bank server data, situated at Mumbai, collapsed due to the high sea level or flood factor and not shifted to other dry area like Ahmadabad or Delhi, may bring peril at any moment in the whole banking business. Are these types of ESG risks, accounted in the BRSR disclosure. No. The BRSR disclosure, has been poorly treated by the directors. There are several examples in the BRSR disclosures released by most of the banks. This is lack of knowledge & skill of directors, for reporting anything of their choice without proper audit and assurance.
"S" Factor Risk of Banks Involving "Talent Management":
Similar problem is seen with the "Talent Management" in "S" pillar. In European Commission, the "Talent Management" is identified as high risk area. But, this is very poorly accounted in India. This is lack of knowledge of the ESG practices. The Covid pandemic has demonstrated this "S" risk very clearly. How Indian Banks can shut their eyes! Banks have been directly affected with the high ESG risks during the COVID-19, where higher sickness rates leading to a sudden reduction in manpower had been witnessed; the shutdown of manpower movements allowed another risk of homeworking in Talent Management.
Large attrition rate of human resource is high risk in banking sector. This is very least considered area in banks. This risk, arises due to several poor HR practices. One of them, is poor salary or missing of benchmarked salary. This is a high social risk of high degree and problem, where attrition has suddenly placed a condition with shortage of talent. Since, talent operates in good HR practices. This is the responsibility of the Social Auditor, to identify the high risk area covering the Talent Management and provide guidance to the banks, how this risk can be eliminated.
The BRSR framework which accounts ESG risk, has incorporated the Principles 1 to 9 under the National Guidelines on Responsible Business Conduct. This has accounted ESG risk under separate column. Wherever risk, has no separate or specified column or which has no place in the BRSR format, as stated earlier, appears in "Other" column. The Axis Bank in its BRSR disclosure of 2021-22, has changed the format and not accounted here correctly the other ESG risk issues. This was done either to suppress information or supply that disclosure, which is "Most Convenient".
High Banking Risk Not Appearing In BRSR Disclosing ESG Due To Poor Banking Practice :
Since, following classified high risks are not appearing in audit and assurance of ESG Audit. Hence, banking sectors, directors are taking pretending method to hide several banking risks. The Hayne Royal Commission in 2018 in Australia reported that misconduct in financial services and behavior that fails to meet community expectations are high risk demanding legality and professional ethics. The analysis of some 314 cases of misconduct recorded in Australia between January 2017 and September 2018, disclosed that, in all cases involving relationships between a banking sector and its customers or clients (some 255 of the 314 cases) i.e 81% cases had relation with the high banking risk involving human right violation.
Basel Committee on Banking Supervision, in 2011 also stated that the risk of losses resulting from inadequate or failed internal processes, people and systems or from external events including legal risk are challenging human right violation issues.
Kym Sheehan and David Kinley, in 2018 demonstrated further that, "Banking Misconduct" and "Human Right Violation" risk are two major high risk in banking sector. These are following risks :
Banking Misconduct:
a) Providing inadequate information to regulator, shareholders, or investors .
b) Failing to inform customers real cost of the banking product; or nature of the banking product.
c) Not proper bank license to handle certain banking products.
d) Imposing unfair contract terms on customer client including that terms for which customer pay charges.
e) Unfair dealing, fraud and misappropriation or misleading deceptive conduct while handling banking product.
Human Right Risks:
a) Breach of Economic security: This is an important human right category for financial services. It’s a principal reason why a person engages with the banking sector. Mass online banking fraud is on this category.
b) Loss of Voice: This is another human right related risk in banking sector, where customer voice is not heard. This requires not only hearing but providing correct satisfied solution
c) Loss of Health and safety: This is another banking risk. The Hayne Royal Commission has observed that the customers experienced stress and anxiety from the losses they suffered in relying upon the wrong advice given by the banking sector.
All these ESG high rated risks appear in BRSR practice, only after conduct of independent audit and assurance by third party auditor.
Conclusion:
The ESG reported in BRSR framework needs honest treatment and proper ESG Audit from qualified "Social Auditor". The wrong BRSR disclosure submitted by the Axis Bank in 2021-22, is extremely worrying point. According to an RBI annual report, the private sector bank has accounted for 66.2% of total frauds. In Axis Bank fraud has alone been reported with 6,124 cases (This is worth Rs. 25.07 crore ) in FY21-22. This was the BRSR "Material Part", coming in Principles 1 to 9 under the National Guidelines on Responsible Business Conduct. This is missing from the disclosure. This is pure "Banking Misconduct" and attracting the "Human Right Violation".
This is lack of skill of director or what? There is gross violation of not reporting correctly the BRSR report. The call may be taken by the SEBI, why Axis Bank did such major compliance failure?
Thus, the ESG risk can't be restricted alone to the general practice of the "Most Convenience" culture, what the Axis Bank has adopted. But, this culture, is required to be shifted to the "Most Meaningful" and honest reporting, covering the high risk ESG issues.
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