If you are a sustainable investor, can you own any bank? They are not the first thing that comes to mind. In terms of the environment, they are great lenders to the fossil fuel industry. Socially, they played a big role, say, in the financial crisis by taking too much risk. In terms of governance, they have been fined time and time again by regulators for money laundering, business scandals, you name it.
But with the bleak landscape for investment returns that is 2023 now upon us, some fund managers think they can justify the inclusion of some banks in their sustainable funds.
And they have decent reasons: the broader investment case for banks in an environment of rising interest rates, the vast room for improvement in cutting their emissions, and the positive impact they can have, both environmentally, encouraging customers to reduce emissions, and social – especially in emerging markets.
Let’s take the broader investment case first. With interest rates rising after years at ultra-low levels, banks are taking advantage of the current difficult economic environment. The latest suggestions from the Davos Economic Summit suggests that the global economy may not slow down as much as previously feared. And balance sheets were strengthened after the 2008 global financial crisis hit, putting banks in a reasonable position to weather any storm. All of this is attractive to dividend-seeking retail investors – and return-seeking fund managers.
At the same time, banks have considerable room to improve their own sustainability records. In 2021, the world’s 60 largest financiers financed fossil fuel companies to the tune of $742 billion, just a little less than the $750 billion recorded in 2020, according to the latest annual report from the Rainforest Alliance Network.
Which is bad, from the point of view of environmental, social and governance standard (ESG). But banks are increasingly promising to limit their fossil fuel lending and boost green financing. That seemed to be good, if we could trust them to do it.
Pressure for progress is mounting, with regulators taking more notice of the problem. The European Central Bank noticed in its inaugural climate stress test on banks last year that underestimated their climate risks. The Bank of England said that banks that failed to manage their climate risk could suffer an annual hit to their profits of up to 15 percent.
Some sustainable fund managers are taking a best-in-class approach to banks, opting for lenders that do the most to reduce fossil fuel borrowing and their emissions.
For retail investors who want to find out which banks are the most sustainable, a shortcut is to look at which banks are the most popular among sustainable funds. An analysis by Morningstar Direct for this column has the result: the most famous bank held by sustainable funds is BNP Paribas, followed by ING, Intesa Sanpaolo, JPMorgan Chase and Société Générale.
Given that it is the world’s largest lender of fossil fuels, it is somewhat surprising to see JPMorgan on the list. But if it finances fossil fuels with one hand, it has made great commitments to finance green initiatives with the other.
The others in the top five are European, which makes sense, according to Hugo Dubourg, a sustainability analyst at JPMorgan, since the European Union is ahead of most other markets on ESG-related regulatory issues.
A report by ShareAction in December found BNP Paribas ranked highest on key climate and biodiversity metrics, followed by Société Générale, Crédit Agricole, ING and Barclays – although the report warned that banks in general had a long way to go.
Dubourg says that biodiversity is emerging as a way for companies to differentiate themselves. BNP Paribas, for example, which is the highest in biodiversity commitments in the ShareAction report, has only promised to provide financial products and services to clients with a “zero deforestation” strategy by 2025.
John William Olsen, a sustainability manager at M&G, sees ING as part of an investment strategy in companies aligned with the Paris Climate Agreement, with the Dutch bank achieving carbon neutrality well ahead of its peers in 2007. according to a report by S&P Global Market Intelligence.
Rebecca Maclean, manager of the Abrdn UK Sustainable responsible investment equity fund, says that the banks are an example of what she calls “improvers”: companies that are transitioning to net zero. But she says you need “an element of skepticism” when it comes to commitments made by banks: “You need to follow their progress against their commitments.”
In the UK, he recently invested in NatWest – ranked joint nine out of 25 in the ShareAction report – pointing to a recent initiative to deliver £100bn of climate and sustainable finance to clients by the end of 2025.
Another reason sustainable fund managers should consider banks is that they are well placed to have a wider positive impact. Some sustainable fund managers in emerging markets invest in local banks with microfinance initiatives for poorer clients.
“The financial sector is a very exciting sector to invest in from a sustainability point of view, as a substantial proportion of emerging markets are underserved,” says Juliana Hansveden, an emerging markets portfolio manager at Ninety One.
Hansveden likes Bank Rakyat Indonesia. Her positive microfinance approach is, she says, in stark contrast to the stereotypical “lazy, risk-averse” approach of many banks in emerging markets.
Of course, the smaller, local banks in emerging markets come with their own risks, from currency to governance: Olsen says that some banks do not have good enough governance to be included in the portfolio.
In general, this kind of sectoral approach to sustainable investing can make sense in a world where there are no longer easy returns, both in ESG and in the broader market. vEven more than before, ESG-oriented investors must combine the pursuit of returns with the pursuit of sustainability. As Maclean says: “It’s a combination of financial conviction and ESG conviction.”
Alice Ross is an FT contributor. His book, “Investing to Save the Planet,” is published by Penguin Business. Twitter: @aliceemross