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In 2020, 67 large-scale banks with assets of more than EUR 200 billion faced 770 scandals linked to failures in their internal controls, corruption and money laundering, and 234 new cases have been recorded between January and June 2021. Banks in Europe faced the most allegations with 543 cases, followed by those in Asia Pacific with 237 cases. Recently, 10 major banks were barred from bond sales by the European Commission following past involvement in breaches of anti-trust rules.
Amid tightening rules on money laundering, regulatory risks for banks are increasing. In Europe, the European Commission is pushing for the creation of a new authority to police financial crime, while the European Central Bank is working with the European Banking Authority and other Anti-Money Laundering (AML) supervisors to implement new regulatory requirements. In the US, the Financial Crimes Enforcement Network released new guidance providing banks with further clarity about the Patriot Act Section 314 (b) requirements in December 2020 which permits banks to share information amongst themselves to identify and report to the government money laundering or terrorist activities, and legislative changes to the AML Regulatory Regime have been passed.
We find an inverse correlation between a region’s Global Corruption Index score and the transparency of internal controls systems across the region’s banks (see Figure 1). In other words, regions with a high corruption index score tend to have a lower share of companies disclosing transparently on their internal control systems to check compliance issues. Banks are expected to go beyond adhering to compliance related regulations by supporting and promoting an internal culture of responsible business conduct. This can be through, for example, regular training and workshops to improve business ethics knowledge and awareness. However, only 27% of banks under our coverage have disclosed putting these types of structures in place. An example of such practice comes from BNP Paribas, which has set targets related to its ethics culture and committed to maintaining the share of employees trained on ethics and conduct issues at higher than 95% by the end of 2021.
Launched in April 2021, the Glasgow Financial Alliance for Net Zero (GFANZ) is an initiative that includes more than 160 financial institutions, with the goal of mobilizing capital to build a global zero emissions economy and delivering on the Paris Agreement goals. Under this umbrella, the industry-led Net Zero Banking Alliance (NZBA) brings together banks with a focus on delivering the same goals for the banking sector with collaboration, rigor and transparency. At the time of writing, GFANZ includes only 25% of the banks we assessed globally in 2020. Those that are members receive an average Climate Risk Disclosure score of 56/100 according to our analysis – compared to the sector average 50/100 (see Figure 2). This constitutes a “limited” performance and indicates that banks have significant room for improvement in providing climate-related information to their stakeholders.
Following the Task Force on Climate-related Financial Disclosures (TCFD) recommendations, banks are expected to disclose climate-related risks in their lending portfolios and other financial intermediary business activities. In our analysis, we find that 64% of banks disclose the physical risk exposure of their business activities in 2020. We expect improvement in these types of climate-related disclosures as banks continue to understand better the requirements and gather resources to align with the recommendations.
Only seven banks in the sector (10% of total) disclose ESG metrics with performance targets that appear in the variable remuneration of their executives. ESG metrics related to customer satisfaction and human resources development accounted for the majority of the metrics linked to executive pay. Other disclosed ESG metrics relate to business ethics and some social and economic development criteria. Given the expected role of financial institutions in the shift towards a low-carbon economy, it is important to note that ESG metrics related to corporate financing contributions to the energy transition – such as green asset ratio or GHG emission metrics – are generally missing from the executive remuneration plans of banks.
Evolving importance of ESG issues for stakeholders should lead to a rise in ESG metrics featuring in executive remuneration plans in 2021 and beyond. This will increase executive accountability in implementing ESG criteria in credit risk management of portfolios and investing strategies, as well as strengthening the role of ESG in long-term value creation. Executive accountability will help companies manage reputational risks in the face of changing appetite amongst investors.
Beyond the inclusion of ESG metrics in remuneration plans, there is an increasing expectation from all stakeholders on the transparency of executive remuneration. The average performance on executive remuneration for banks assessed between the beginning of 2021 and Q2 2021 stands at 34.5/100, a steady improvement from previous years. (see Figure 3)
In a bid to cut their cost-to-income ratios in the era of low interest rates and post-pandemic recoveries, banks – particularly those located in Europe – are unveiling plans to lay off workers. Such plans will test the ability of banks to manage potential social issues and human capital risks and have the potential to impact how they attract new talent in the future. On the management of responsible reorganization, the average ESG performance has improved to 40/100 as of June 2021, from 35/100 in 2020. Most banks have reported on compensation and early retirement plans for affected workers but lack more advanced support linked to re-training affected workers or providing them with outplacement services.
Looking ahead, teleworking will continue post-pandemic on a more permanent basis. There are identified benefits to teleworking for both companies and employees. However, significant psychosocial risks can’t be discounted in a sector already exposed to work-related stress. In addition, concerns of work-life imbalance, increased exposure to stress caused by working with computer technology daily (“technostress”) and general work overload are prevalent in the sector. We saw disclosures on mental health and stress policies from 58% of the banks we assessed in 2020, while 66% of banks have measures to detect and manage stress such as training, work-related stress risk assessment, psychological support and work-life balance arrangements (see Figure 4).
Biodiversity loss is the next frontier in financial risk management. Conventional financial risk assessment significantly underestimates the risks from environmental damage. In South America, the forest area net change between 2010 and 2020 stood at -2.6 million hectares per year and -3.9 million hectares in Africa within the same period (see Figure 5). Continuous loss of forest area contributes to global warming and will increase physical risk exposure of the banks’ assets in these regions as well as their credit risk profiles and those of their clients. The performance of European and North American banks in the development of green services and products that cover relevant issues such as mitigation of biodiversity loss has improved in Q2 2021 compared to the previous year’s performance. However, the most affected regions– Asia Pacific and Rest of the World – are not showing the same improvement (see Figure 6).
We expect to see improved and standardized reporting from banks on biodiversity impact assessment and metrics to drive effective assessment of risks associated with the management of natural capital. For example, the “Finance for Biodiversity Pledge” was launched in September 2020 which now includes 56 banks, asset managers, insurers and impact funds committed to collaborate, engage, assess their own biodiversity impact, setting targets and reporting on biodiversity by 2024. Furthermore, the Task Force on Nature-related Financial Disclosures (TNFD) was formed in July 2020 with with the goal to provide financial institutions and companies with better information on nature-related risks and opportunities.
For more information, visit esg.moodys.io/esg-measures
