The banking industry is undergoing a paradigm shift. This is driven by the strong influence of environmental, social, and governance (ESG) considerations, especially concerning the risk profile of retail customers. Traditionally, banks were solely focused on financial metrics to assess retail customers’ creditworthiness and overall risk.
However, with the growing importance of sustainability, social impact, and ethical practices, ESG factors are becoming vital in determining the risk profile of individual customers. We will try to delve into the transformative impact of ESG on retail customers’ risk profiles, highlighting the benefits for both customers and the banking sector, say Sourav Ghosh, senior industry principal, Infosys BPM and Suraj Kambale, lead data analyst, digital transformation services, Infosys BPM.
A study published in the Journal of Real Estate Finance and Economics conducted an analysis using data from the Global Real Estate Sustainability Benchmark and other research by Fordham University. It concluded that “real estate investment trusts (REITs) with higher levels of ESG disclosure have lower debt costs, higher credit ratings, and higher unsecured debt to total debt ratios,” concluding that governance and ethics lower the cost of capital rather than better credit ratings.
These results show that ESG can influence the performance of all asset classes. These results make intuitive sense, as ESG principles tend to promote efficiency, innovation, and integrity. Let’s find out how the banking sector is rewarding retail customers with a more ESG-sound risk profile.
1. ESG-focused loan products
The banking sector was an early adopter of the opportunities in ESG and started focusing on the same before other sectors. Banks are increasingly offering ESG-focused loan products to incentivise environmentally conscious and socially responsible retail customers. By aligning financing options with customers who prioritise sustainability and ethical practices, banks can cater to growing market demand. These loan products may come with lower interest rates, longer repayment periods, or favourable terms for energy-efficient home improvements, green initiatives, or eco-friendly vehicle purchases. As customers embrace these sustainable options, their risk profile improves due to a demonstrated commitment to responsible consumption.
2. Impact on payment pattern
Traditional risk assessment often fails to capture the full picture of a retail customer’s creditworthiness, neglecting important ESG-related factors, obviously because there is no standard definition that can explain ESG. However, emerging risk assessments are integrating ESG data to provide a more comprehensive evaluation using factors such as low carbon footprints, positive social impact, and ethical governance practices to identify customers with a strong ESG performance. Banks can add another matrix in risk assessment for ESG parameters, namely the area of the customer along with the geopolitical data, to get a better understanding of the customer profile. Such positive performance metrics may receive higher credit scores, leading to improved access to credit and better loan conditions. This not only benefits responsible customers but also encourages others to adopt sustainable practices to enhance their creditworthiness.
3. Impact on loan terms
The incorporation of ESG factors in risk assessment can impact the loan terms offered to retail customers. Customers with a positive ESG profile are perceived as less risky due to their potential for long-term financial stability and a reduced likelihood of reputational damage. Banks may offer such customers more flexible repayment schedules. Conversely, customers with poor ESG performance may face higher interest rates or more stringent loan conditions. Thus, ESG considerations are influencing the overall pricing and accessibility of credit for retail customers.
4. Green mortgage loans
One significant impact of ESG on mortgage loans is the emergence of “green mortgage” products. Green mortgages are specifically designed to finance properties that meet specific environmentally friendly criteria, such as energy-efficient homes with renewable energy systems or properties adhering to eco-friendly construction standards. Lenders may offer lower interest rates, reduced down-payment requirements, or other favourable terms to encourage borrowers to invest in energy-efficient and sustainable properties.
5. ESG-integrated risk assessment
Lenders are increasingly incorporating ESG factors into their risk assessment for mortgage loans. By evaluating the environmental impact and social responsibility of borrowers, lenders can gain a more comprehensive view of a borrower’s creditworthiness and long-term financial stability. Borrowers with a positive ESG profile may receive more favourable loan terms due to their demonstrated commitment to sustainable practices and responsible homeownership.
6. Property resilience evaluation
ESG considerations can also influence how lenders assess the resilience of properties to environmental risks. With an increasing number of natural disasters and climate-related events, lenders may evaluate the vulnerability of properties to factors like flooding, wildfires, or extreme weather conditions. Homes built to withstand such risks or properties located in areas less prone to environmental hazards may receive more attractive mortgage terms.
7. ESG investment opportunities
Banks are increasingly encouraging retail customers to invest in ESG-focused products, such as green bonds, sustainable funds, and socially responsible investments. As more individuals seek to align their investments with their values, banks can support their clients in making responsible investment choices. Customers who invest in ESG-aligned funds can diversify their portfolios while contributing to positive environmental and social impacts. Banks may reward such investors with enhanced services and benefits, enhancing their risk profile through responsible investment decisions.
The integration of ESG factors in risk assessment is reshaping the risk profile of retail customers within the banking industry and across all banking products and services. By offering ESG-focused loan products, incorporating ESG data into risk assessment, and encouraging responsible investments, banks can incentivise retail customers to embrace sustainability and social responsibility. Customers with a strong ESG performance benefit from improved access to credit, favourable loan terms, and enhanced investment opportunities. Simultaneously, banks foster a sustainable banking ecosystem, contributing to positive environmental and social impacts.
As ESG considerations continue to gain prominence, the risk profile of retail customers will increasingly reflect their commitment to responsible practices, creating a more responsible and resilient banking sector.
The authors are Sourav Ghosh and Suraj Kambale of Infosys BPM.
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