The ESG Turning Point in the Banking Sector: Towards Sustainable Growth

In recent years, the focus on Environmental, Social, and Governance (ESG) criteria has grown exponentially in the financial sector, with the banking industry at the forefront. The integration of ESG factors is now crucial for the banking and financial system, serving as the foundation for a sustainable growth model capable of ensuring resilient progress over the long term against potential external and internal shocks.

Starting in May 2020, the European Banking Authority (EBA) introduced Guidelines for the management and monitoring of loans, emphasizing the importance of ESG issues. These directives require credit institutions to develop transition plans aimed at achieving a prudent alignment between the risks undertaken and the regulatory and climate objectives of the European Union. This necessitates detailed strategic planning in the short, medium, and long term, in compliance with the Climate Law, the Green Deal, and the recommendations of the European Commission.

The implementation of these directives represents a paradigmatic shift in creditworthiness assessment criteria. Evaluation is no longer strictly tied to business continuity but extends to business sustainability, considering the economic and financial robustness of companies alongside environmental, social, and governance factors.

New risks associated with the transition are emerging, including technological risks arising from the adoption of new technologies and the abandonment of high-emission assets; regulatory risks linked to climate policies such as the Green Deal and emissions trading systems (ETS); legal risks related to climate litigation; and the risk of carbon lock-in, concerning the persistence of high-emission activities in loan portfolios.

In this sense, increased exposure to ESG risks negatively impacts the company’s rating and, consequently, the cost of debt. As a result, in an effort to reward more virtuous companies regarding sustainability and reduce risk for lenders, there has been a rise in new covenants (so-called “green covenants”) in recent years. These allow the financed company to tie (positively and negatively) the conditions of the financing to the achievement of specific environmental targets. In cases of covenant breaches, “step-up” events can occur, meaning an increase in the interest rate applied to the loan, potentially even leading to the loss of benefits.

On the other hand, delays in the transition to sustainable business models not only pose an environmental threat but also represent a significant financial risk for banks, potentially increasing credit losses. A study by EY estimated that the overall cost of credit risk for Italian banks could range from €14 billion to €41 billion between 2024 and 2050, depending on the climate scenarios considered:

• “Below 2°C” Scenario: A virtuous scenario with the immediate implementation of gradual climate policies, associated with contained transition risks and a “base” credit risk.
• “Nationally Determined Contributions” Scenario: With moderate and heterogeneous climate policies at the national level, it entails high physical risks and an increase in costs of about €13.9 billion compared to the “base” scenario between 2024 and 2050.
• “Fragmented World” Scenario: With delays and globally divergent climate policies, it incurs an additional cost of €26 billion.
• “Delayed Transition” Scenario: Climate policies adopted only starting from 2030, leading to greater transition risks, incur an additional cost of €40.7 billion compared to the “Below 2°C” scenario.

It is therefore evident that a departure from emission reduction targets will entail increasingly higher costs as the transition becomes inevitable.

The European Central Bank (ECB), in its 2022 “Thematic Review” on climate and environmental risk, noted that about 75% of supervised banks have already integrated ESG risk factors into their business strategies by identifying specific indicators. However, only 15% have developed processes and tools to effectively monitor and manage these risks.

The primary cause of this partially negative assessment is attributed to the lack of availability of accurate data and market transparency, making it difficult for banks to obtain the necessary information to reliably assess whether the products offered to customers are “green” (considering green mortgages, which, in the absence of an Energy Performance Certificate, must rely on estimates or self-certifications).

Beyond data management, banks face the challenge of quantifying the benefits of offered financial products. Current metrics do not always allow for precise quantitative assessment of benefits, often forcing the use of traditional metrics and aggregate evaluations.

In particular, while for “Large Corporate” clients, more precise recovery of information at the individual company level can be anticipated, leading to specific analysis of estimated benefits and targeted strategies, for SMEs it is very complex to reliably recover data, often resulting in the use of “off-the-shelf” products, which could cause significant differences in actual benefits achieved between one counterparty and another.

Finally, the regulatory complexity surrounding sustainability represents an additional challenge. In recent years, the EU has introduced a wide range of regulations and acronyms that must now be “digested” by market operators. Financial education thus becomes essential, with banks playing a crucial role in guiding customers through this complex regulatory landscape.

Many banks have already taken steps in this direction, such as Banca Progetto, which last March signed a partnership with Circularity, an innovative startup and Benefit Company dedicated to the circular economy that supports businesses in integrating ESG principles, consolidating all necessary tools for embedding environmental sustainability into their business in one place: training, measurement tools, and technical-strategic consulting for circular economy and ESG issues. The agreement allows companies registered on BusinessPlace (i.e., the online portal dedicated to Banca Progetto’s clients) to access Circularity’s offerings with an all-inclusive package at favorable economic conditions.

In summary, the banking sector is called to a significant turning point: the integration of ESG criteria is no longer a mere option but a fundamental pillar for ensuring future sustainability and resilience. This transformation not only addresses pressing ethical and regulatory demands but also represents an indispensable strategy for reducing risks and seizing new market opportunities.