ESG bites into banks’ lending to corporates, says a report by Fitch Ratings.

Fitch Ratings fielded a survey in the third quarter of 2019 and received 182 responses from banks. The survey examined how environmental, social and governance (ESG) considerations are finding a place in banks’ risk, financing, and prudential supervision frameworks.

“The influence of ESG on banks lending decisions will continue to grow. But corporate rating actions due to ESG -related bank funding decisions are likely to remain rare,” said Monsur Hussain, Financial Institutions Research at Fitch.

The report found that ESG screening led to greater due diligence on deals rather than their outright rejection.

However, ESG-driven decisions are already affecting the ability of companies to refinance. Furthermore, ESG considerations have driven credit rating downgrades in only exceptional circumstances.

Key findings from the Fitch report on banks and ESG

Impetus for ESG

Internal company policy and regulation practices led banks to scrutinize borrowers for ESG factors. Application of such ESG policies affected about half of the surveyed banks’ lending assets.

ESG no-go sectors

Banks considered human rights violations as the single most important factor for denying financing. Secondly, especially in developed markets such as Western Europe, policies did not permit project financing for thermal coal mining and coal-fired power stations. Certain EU banks avoided financing weapons manufacturers.

Candidates for ESG screening

Metals & mining, and chemical & fertilizers were sectors most likely to be examined for environmental risks. On the other hand, borrowers in the gaming & leisure sector could find themselves under the lens for reputational risks arising from social issues such as addiction, crime and money laundering.

ESG risks to borrowers over the short to medium term

“Direct corporate rating impacts due to ESG -related bank funding decisions are likely to remain rare, especially for the refinancing of existing borrowings or projects,” the Fitch report said.

ESG risks to borrowers over the longer term

“Sectors facing greater challenges in obtaining bank financing will also be those that are most exposed to other ESG -related risks, such as emissions regulations and the rising cost of carbon.” Further, as social and regulatory pressures grow, banks will be compelled, more and more, to scan for ESG risks. This trend will, therefore, have a growing influence on banks’ financing decisions.

Transition financing

“We believe ‘transition financing’ will become a vital route for the worst-affected entities to obtain bank financing (and for banks to continue providing credit to high ESG-risk entities), to manage the potentially costly transition to a low-carbon economy,” said the Fitch route.

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