How Small Financial Institutions Need to Handle ESG — Today and Tomorrow

Financial institutions of all sizes are in the midst of an ESG revolution despite strong headwinds that make transformation challenging, from roadblocks like inadequate data collection to low employee engagement. While these internal issues can often be managed, external pressures are making matters even worse.

Anti-ESG efforts have surfaced from more than a dozen state attorneys general, and the Federal Reserve has made it clear that interest rate increases will be the norm, even if that means kickstarting a recession.

The sheer size of America’s largest banks allows them to weather the ESG storm more easily than their smaller counterparts, many of which may consider tightening their belts by slashing what they view as non-essential programs, potentially including their ESG efforts to their detriment.

Why ESG programs are important

Many smaller to mid-size banks that might be tempted to cut sustainability or ESG programs should first understand that sound financial materiality/risk management practices and regulatory expectations favor investing further in ESG rather than cutting back. The economic impacts of ESG issues like climate change cannot be ignored by financial institutions or their regulators. Financial institutions of all sizes can either lead, follow or get left behind.

The good news is that many institutions, including smaller to mid-sized ones, likely have numerous fully functioning components of an ESG program already in place. The HR, risk/credit and Compliance departments tackle ESG issues daily. The board of directors and senior management exist to ensure the use of sound corporate governance practices. Banks that are subsidiaries of listed companies on a national exchange have long been complying with the listing standards that set forth governance requirements. And smaller to mid-size institutions are arguably better poised to address the specific needs of their communities than megabanks.

In examination proceedings, the difference between supervisory and enforcement actions lies with the culture and direction of the entire institution, not just that of a particular team or committee. While there are scant explicit ESG-related exams happening as of this writing, institutions can prepare by proactively leveraging existing resources to build a holistic ESG program. Doing so would demonstrate an organization-wide commitment to the program and compliance matters.

Additionally, multiple existing regulations already address ESG. These include (but are not limited to):

• The Home Mortgage Disclosure Act (HMDA)
• Community Reinvestment Act (CRA)
• Fair Credit Reporting Act (FCRA)
• Flood Disaster Protection Act (FDPA)
• Equal Credit Opportunity Act (ECOA)

There are certainly current exams of compliance with these regulations. The present version of the CRA does, in fact, address climate change by promoting investments in green jobs or protecting buildings from flooding and fires in underserved communities. In some regions, state-level versions of the CRA have been expanded to provide credit for institutions that incorporate climate considerations into their activities. 

How to build a program

Of course, you can’t think about pulling back on an ESG program that doesn’t exist, so how does an ESG program get built in the first place? The following five steps provide a high-level roadmap to construct an ESG program.

• Research. Research current operations and community needs. Your ESG strategy cannot be separate from the broader organizational strategy. Utilize a reporting framework, like GRI (Global Reporting Initiative) or SASB (Sustainability Accounting Standards Board) to produce an initial report.
• React. Circulate the report throughout your organization. Receive feedback at all levels and use those responses to drive strategic initiatives that bolster your organization’s ESG credentials. Accelerate and de-risk your ESG journey by ensuring your program is authentic, grounded in data, aligned with the broader business strategy and the needs of key stakeholders (both internal and external) and fully integrated across the organization.
• Execute. Implement and track your initiatives at an established cadence.
• Report. Produce reports and collect data for internal and external use to drive progression toward your ESG targets.
• Communicate. Finally, communicate your ESG journey to the public and establish a process to publish an update regularly.

Going beyond the basics

There are both turnkey and custom ESG solutions available to help get your institution’s program off the ground. If an institution is further along on its ESG journey, the program may simply need to be upgraded through things like:

• Benchmarking with local and national competitors (what is good in New York may not be good for West Virginia).
• Understanding how the ERM structure at the institution should examine, assess, implement and measure ESG strategies.
• Determining how ESG policies and procedures impact compliance, HR, credit, risk, and investment policies and procedures at the institution.
• Establishing sound data management practices for compliance with program and ESG policy.
• Setting KPIs and strategic goals that are relevant, defensible, and add value to a business.
• Reinforcing disclosure preparation by creating procedures to assure that the information is accurate and compliant.

Investing in the future

Many financial institutions limit their strategic and operational planning to a short time scale of five years or less. This practice intentionally leaves longer-term risks and opportunities unanalyzed. Building a successful ESG program requires looking far into the future — to the next recession, pandemic or geopolitical crisis in the decades to come. It can seem overwhelming, but the work put in now by the current organization — where the stakes are lower and there is time to develop adequately — will reap invaluable benefits for the future organization.