The Banking Industry, Credit Risk

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The Banking Industry, Credit Risk
Sustainability Issues ----

• Is Being Green Financially Responsible?

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Research Hypothesis Integrating Sustain-ability
Makes Risk Management Sense

• If banks believe this, they might take various
  actions
• Add sustainability protocols to the risk
  assessment process
• Increase training of credit people
• Increase use of external experts
• Monitor ongoing credits on these issues
• Shift responsibility for these issues to the line

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Why Credit Providers Might Integrate
Sustainability Items Into Risk Mgt. Process

• Reduce Risk
• Facilitate making loans they might not have made
• Consistent with Basel II
• Transparency - Post Enron, Ahold world
• Good public relations
• Employee reaction

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Some Background Data

• 1990 - Banks started looking at issue
• Early 1990s - Guidelines/regulatory action
• Late 1990s - Most actions in financial services
  is on insurance and asset mgt.
• 2003 - Equator Principles Announced
• 2004 - Our Research
• 2005 - Basel II

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Research Methodology

• Talk to as many EP Signatories as possible
• Talk to leading non-signatory banks
• Talk to a wide range of people at each
  institution
• Look to get beyond public statements
• Learn what they are doing and plan to do in next
  few years

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Main Areas of Focus

• Credit risk process (pre post decision)
• Training activities
• Signing/not signing the Equator Principles
• Where responsibility lies for decisions
• Staffing (internal external experts)

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Who We Talked To 38 Institutions
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Who We Talked To 80 Officers

• .

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Highlights of What They Said

• 90 of the institutions contacted now have
  credit, operations, or direct line staff fully
  dedicated to these issues
• All but one (1) institution has training efforts
  on how to manage environmental credit risk
• 50 of the institutions have committed
  individual senior staff members from each core
  discipline on a full time basis to the issue

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Additional Findings What They Are Doing

• Most do not plan to use external experts except
  on specific transactions
• Most want to create an environmental risk team
  inside the credit department
• Public relations still a big deal
• They are promoting their actions to staff

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Additional Findings What They Are Not
Necessarily Doing

• They talked about revising their credit processes
  but most had not changed them yet
• Most were still not looking at credits post
  commitment stage
• Most not looking at The Environmental Industry
  as an area where they plan to focus their new
  business credit extension activity
• Not weighting best sustainability programs as a
  reason to give better terms or more access to
  credit (i.e. still not a positive screening tool)

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Research Findings Some Information Gaps/Issues

• Banks still not sure how to show how
  environmental issues make credits go bad
• Lack of any real data on non environ-mental
  issues related to corporate performance
• Customers (corporate and individual) say they
  care, but don't appear to take pro-active or
  re-active actions (dont change banks because of
  these issues)

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What Had They been Doing

• Most banks had been decreasing staff in the late
  1990s/early 2000s
• Most had stopped training line staff
• Guidelines and regulations from external sources
  no new ones and less focus on existing ones

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What Caused The Recent Change

• The Signing of the Equator Principles by 10
  leading banks in June 0f 2003
• Basel II
• More push by NGOs
• More push by major development banks
• The Broadening of EP since 6-03
• More Banks in More Countries
• Application of EP guidelines to other credit pdts.

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Why Havent More Banks Signed The Equator
Principles?

• Concern about formally signing a set of
  guidelines they can not adjust, and others might
  adjust for them
• Already doing it all, no need to sign
• Think EP goes too far and it is too hard to be in
  full compliance with
• Still taking a watch and see attitude
• Will be held to an unrealistic standard in non
  OECD countries

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What It Means In Practical Terms?

• Adding full internal staff to look at these
  issues (50 adding people)
• Limited use of external experts (use only on
  transactions, not for process or strategic
  aspects) (83)
• Plan to add additional processes to manage and
  mitigate these risks (67)

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What It Means In Practical Terms?

• Increasing training activities (60)
• Ongoing dialogue with representatives of NGOs
  (73)
• Talking with clients about these issues, (before
  - close to 100) and (after less then 25)
  funds are committed

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Where Will It Lead/Has Led?

• Environmental credit risk management becoming a
  part of every large credit
• It is being implemented by most major credit
  institutions in OECD countries
• The term financially material continues to
  become a smaller monetary value
• Governmental agencies will start to codify
  guidelines related to financial services

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Where Will It Lead/Has Led?

• 40 institutions have now signed the EPs
• Bigger institutions continue to role-out programs
  to all their locations worldwide
• Basel II is being recognized by more non- OECD
  countries
• Guidelines being tested in non OECD countries
  (e.g. North Africa experiment)

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The North African Experiment

• Support banks and central banks in three
  countries to establish sustainable banking
  principles appropriate for their country
• Establish environmental/social credit risk mgt.
  guidelines in Egypt, Tunisia, and Morocco and
  then train bank management
• Once established in 3 countries, role out to
  other African/Middle Eastern Countries

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Big Unknowns About The Future

• When banking profits deteriorate will banks
  maintain their commitment?
• Will transparency remain important as Enron and
  Ahold become distant memories?
• Will they shift their focus from risk management
  to image management?

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Big Unknowns About The Future

• Will these financial institutions make the needed
  financial commitment to establish and implement
  effective internal and external (i.e., at the
  client level) programs and processes?
• If these institutions make and maintain their
  commitment, will it lead to the tipping point
  where all global credit providers will follow
  suit (a leveling of the playing field)?
• ONLY TIME WILL TELL!!!!