The Impact of ESG on Taiwanese Banks

In past articles, we’ve reviewed the ESG (Environmental, Social and Governance) reporting mandate for listed companies and how it is gradually becoming clear that even non-listed Taiwanese companies are feeling the need to adhere to the disclosure mandate. However, despite any potential for overlap, I believe there is merit in examining the impact of ESG on Taiwanese banks.

ESG issues as well as their associated opportunities and risks are absolutely relevant to Taiwanese banks. For banks, it is not just an ethical question when it comes to the question of sustainability, it is now an economic question. Heightened demand from investors for sustainable products as well as ever-increasing pressure from regulatory bodies highlight the need for banks to build ESG risks into their risk management framework.

So, let’s examine the ESG risk drivers and sustainability issues that banks face and look at how banks must embed them into their risk management frameworks.

Integrating ESG into risk management frameworks

I am positive that if Taiwanese banks take a holistic approach to ESG risks within their risk management framework, they will see clear and tangible outcomes that move banks toward a more effective, efficient, and sustainable risk function. It may even make the unenviable role of Chief Risk Officer (CRO) a little more enjoyable.

Taiwanese banks are set to play an important role within Taiwan’s Pathway to Net-Zero Emissions in 2050 and earlier this month it was revealed by Taiwan’s Central Bank that it plans to incorporate climate change risks into its modeling and forecasts for economic growth. This new strategy is a clear alignment with the Net-Zero 2050 commitment. This move by the central bank sends a clear statement to Taiwanese banks to get on board with ESG now.

Banks are no exception

Let’s burst any preconceived bubble here and now, banks are not unique. Banks don’t have a fountain of knowledge or a crystal ball that allows them to predict the future (well, they do have risk management systems that help in this regard, but some systems are better than others).

After all, banks are simply made up of people and banks have had to deal with a confounding flood of information and speculations about future regulatory changes, and this has made it arguably difficult (but by no means impossible) for banks to develop a comprehensive strategy for ESG factors. Just because something is difficult is no excuse for lack of action.

Act now

Nevertheless, we know that investors across the globe and in Taiwan are demonstrating an increased demand for sustainable financial products. It follows then that sustainability and corporate conduct are influencing the reputation and business success of Taiwanese banks.

Doing nothing and waiting is not an option if it ever was, and I very much doubt that. Banks that are not acting now will hardly have the chance to integrate regulatory requirements regarding sustainability into their frameworks in good time, let alone adapt to the changed market requirements. This failure will attract the unwanted negative attention of both the regulators and the investment community.

I do acknowledge that simple solutions are rare. For example, abandoning a long-term relationship with a client that operates in a pollution-heavy industry can be extremely difficult even if the client itself is making every effort to convert to a more climate-friendly operating process, and exiting the relationship can lead to a loss of the bank’s reputation among this customer group.

Conversely, the continuation of such business, in turn, can upset other stakeholders (such as NGOs) who may accuse the bank of unwillingness to support the transformation process to a sustainable economy. Banks undoubtedly see themselves as stuck between a rock and a hard place, but no one has ever said that banking is easy.

Whilst I noted above that banks are made up of people, there are a lot of smart people in banks and those smart people and the smart banks that employ them can, despite all the challenges posed by ESG factors, find opportunities here. Integrating ESG risks into their business now provides for active positioning and a positive reputation with their customers. They may even find new customers attracted by creating innovative products, solutions, and ideas.

However, ESG risks are not for the faint-hearted when we appreciate that they include environmental risk, social risk, and governance risk with the very real potential of a negative impact on banks’ P&L and liquidity. ESG risks can even affect a bank directly (e.g. storm damage to bank buildings or a bank’s systems), but also affect the same bank’s customers (change in sales opportunities, production disruptions, etc.) leading to, for example, higher loan defaults. These are just two small examples of the very real challenges.

Sound bank governance vital

There are some people who would cynically suggest that banks are “cash cows” and can simply throw money at ESG risks and they will magically go away. Frankly, having worked in banks for more than 30 years, I know that any bank that foolishly throws money at a problem in the hope of it going away will be shocked and horrified at the on-going cost of such an approach and equally as shocked and horrified to find out that the problem has not disappeared and in fact is likely to have grown larger.

In my opinion, this is where sound, reasoned governance within the bank is of vital importance. If the board and/or senior management are not fully onboard with ESG risks in 2023, then that bank is in for some very tough times. Management must step up and meet the challenges.

It is of course, all very well for me to sit comfortably outside Taiwan’s banking system and pontificate on meeting ESG challenges. So, I shall attempt to prove my worth and provide some ideas about what Taiwanese banks should be doing now if they aren’t already:

• Sustainability must be front and center of your business strategy today.
• ESG risk must be a priority in your organizational setup/governance — the ESG message must come from the top.
• Make sure you have the right talent for your on-going ESG journey. If you don’t have them, get them, and ensure they have the tools and support they need. It is a tough market for ESG talent, but talented resources exist — use them.
• If necessary, make appropriate adjustments to your product and customer portfolio. This will not be easy or pleasant. It may involve the most difficult of decisions to de-risk certain products or customers, but it must be done.
• Know and be able to identify your sustainable assets and look for more.
• Offer sustainable financing to customers now. Don’t hint at it as if it is something on the horizon. Offer sustainable financing now!
• ESG risk must be included in your pricing and risk management models today, not tomorrow, not next month.
• ESG risks must be included within your capital charge model now. Again, make sure you have the right credit risk managers to achieve this today!
• Manage your ESG-related data. If you aren’t managing your ESG data now, it will only be that much more difficult in the future. Make sure your data is up to date and renewed regularly. Data burn is real. Don’t get burnt!
• Make it clear to your customers, investors, and regulators of your ESG credentials. Make sure the positive message gets out there and reap the benefits of your hard work.

If the above list sounds dogmatic, I make no apologies. It is meant to be dogmatic. There are many Taiwanese banks that are already taking the correct approach to ESG risks, but I am concerned that there are also many that need to start acting now. As noted above, doing nothing is not an option.

Until we meet again, my best wishes for the upcoming Lunar New Year. Stay healthy, safe, and may 2023 be a year of prosperity for us all!

Our member, Paul Shelton has a 30-year history in banking, working as head of Legal & Compliance and MLRO for the Asia Pacific branches of major international financial institutions in Japan, Singapore, Australia, and Hong Kong. He is also experienced in working with financial regulators across the Asia Pacific and provides consultancy services to Taiwanese financial and non-financial industry associations in all aspects of Compliance, AML/Sanctions, and Governance. He resides in Taipei.