The term ‘ESG’, which stands for all environmental, socioeconomic, and governance concerns, is consequently gaining traction in the business and corporate sector. ESG is about pursuing responsible and ethical business practices with attention to social and environmental parity along with economic development. ESG is fast becoming synonymous with sustainability. Investors and regulators have also amplified their analysis in evaluating businesses that employ sustainable business practises and the ESG framework.
ESG is a set of standards for a company’s operations that socially conscious investors use to choose potential investments. Environmental criteria consider how the operations of a company impact the environment (e.g., emissions or air/water pollution). Social measures examine how it manages relationships with employees, suppliers, customers, and the communities where it operates. Governance deals with a company’s leadership, audits, internal controls, and shareholder rights.
In India’s corporate ecosystem, there have been two major developments in the context of Sustainability/ESG Framework. The first was Corporate Social Responsibility (CSR) reporting and spending being made mandatory under the Companies Act, 2013. The second is the Securities and Exchange Board of India (SEBI) making the Business Responsibility and Sustainability Report (BRSR) mandatory for the top 1,000 listed companies by market capitalisation. This is a step forward in widespread adoption of ESG framework in corporate decision-making and business practices.
Environmental, Social, and Governance (ESG) considerations have become increasingly important for the banking sector in recent years. The banking industry has a significant impact on the economy and society, and as a result, banks have a responsibility to manage their operations in a socially responsible and sustainable manner. ESG factors can have a direct impact on a bank’s financial performance, reputation, and long-term viability.
Need for an ESG Reporting Framework:
(i) Businesses have the power and resources to take good climate action, create a more sustainable, resilient future, and spend their money for this cause. ESG Reporting norms will create visibility to investors about such sustainable actions/practices by companies. The clarity will help the investors to channel their investments in sustainability-conscious companies.
(ii) Globally, the landscape of sustainability reporting is evolving swiftly as a result of the push for the Sustainable Development Goals and the growing momentum of the climate action movement. ESG is becoming more important in this situation.
(iii) Consumers are now demanding high standards of sustainability and quality of employment from businesses. Regulators and policy makers are more interested in ESG because they need the corporate sector to help them solve social problems such as environmental pollution and workplace diversity. The investor community has also become much more interested in it.
Evolution of ESG Reporting Norms in India
ESG reporting in India started in 2009 with the Ministry of Corporate Affairs, Government of India, issuing the National Voluntary Guidelines on Corporate Social Responsibility (NVGs).
In 2012, SEBI mandated that the top 100 listed companies by market capitalisation file the Business Responsibility Report (BRR) based on NVGs along with annual reports. BRR was extended to the top 500 listed companies by market capitalisation in 2015 and to the top 1,000 listed companies in 2019.
CSR activities have been made mandatory under The Companies Act, 2013 for companies falling under the prescribed category.
Integrated Reporting (IR) was introduced by SEBI in 2017 voluntarily for the top 500 companies required to prepare BRR.
The National Guidelines on Responsible Business Conduct (NGRBC) came in 2019.
Business Responsibility and Sustainability Report (BRSR) was introduced in 2021 on a voluntary basis and made mandatory from FY2022-23.
The salient features of SEBI’s BRSR Guidelines:
BRSR is a standardised reporting format that will provide a basis to compare environmental, social and governance goals across companies and sectors.
The BRSR guidelines are more elaborate and stringent than the existing BRR norms. BRSR incorporates metrics of international frameworks on par with global ESG reporting trends. It is a significant step towards bringing sustainability reporting at par with financial reporting.
Some of the key disclosures sought in the BRSR are:
(a) Sustainability related goals &targets and performance against the same
(b) Environmental disclosures related to resource usage (energy and water), air pollutant emissions, greenhouse (GHG) emissions, transitioning to a circular economy, waste management practices, extended producer responsibility, biodiversity etc.;
(c) Social disclosures covering the workforce, value chain, communities and consumers that include:
(i) Employees/workers: Gender and social diversity including measures for differently-abled employees and workers, turnover rates, median wages, welfare benefits, occupational health and safety, training etc.;
(ii)Communities: Disclosures on Social Impact Assessments (SIA), Rehabilitation and Resettlement, Corporate Social Responsibility etc.
(iii) Consumers: Disclosures on product labelling, product recall, consumer complaints in respect of data privacy, cyber security etc.
The 9 principles of National Guidelines of Responsible Business Conduct (NGRBC) are aligned in the BRSR report:
- Business should conduct themselves with integrity and in a manner that is ethical, transparent and accountable.
- Businesses should provide goods and services in a manner that is sustainable and safe
- Businesses should promote the well-being of all employees, including those in their value chains.
- Businesses should respect the interests of and be responsive to all its stakeholders.
- Businesses should respect and promote human rights.
- Businesses should respect and make efforts to protect and restore the environment.
- Businesses, when engaging in influencing public and regulatory policy should do so in a manner that is responsible and transparent.
- Businesses should promote inclusive growth and equitable development.
- Businesses should engage with and provide value to their consumers in a responsible manner.
The BRSR report serves as a single comprehensive source of information on non-financial sustainability measures to all the relevant key stakeholders of the business, i.e., shareholders, regulators, investors, and the public at large.
ESG in Banking Sector:
ESG is a framework used to assess companies’ performance on environmental, social, and governance issues. ESG factors have become increasingly important in the banking sector, as banks are under increasing pressure to align their activities with broader societal goals.
Environmental factors are an important consideration for banks. Climate change and environmental degradation can have significant economic and social impacts, and banks are well-placed to play a role in mitigating these risks. Banks can be exposed to environmental risks in various ways, such as lending to polluting industries or financing fossil fuel projects. Therefore, environmental considerations are becoming more critical in banks’ decision-making processes. Banks are under pressure to limit their exposure to companies that contribute to environmental damage and promote sustainable practices.
Banks can support environmentally sustainable investments, such as renewable energy projects and clean technology, and provide financing for companies that are committed to reducing their carbon footprint. Additionally, banks can incorporate environmental factors into their risk management frameworks, including stress-testing their portfolios for climate-related risks.
Social factors refer to the impact of a bank’s operations on society. Banks have a role to play in promoting social equality and supporting underserved communities. This can be achieved through responsible lending practices, such as providing affordable credit to low-income households and small businesses, and investing in community development projects. Banks can also promote diversity and inclusion within their own organizations and support initiatives that promote social cohesion.
Governance factors relate to the way in which a bank is managed and governed. Good governance practices are critical to ensuring a bank’s long-term success and sustainability. This includes having robust risk management frameworks, transparent reporting, and strong board oversight. Banks that prioritize governance factors are more likely to have better risk management practices, higher levels of transparency and accountability, and better alignment with the interests of stakeholders.
Impact of ESG on Banking Performance
ESG considerations have several impacts on the banking sector. The most notable impact is on the lending and investment activities of banks. Banks are under increasing pressure to limit their exposure to companies that contribute to environmental and social damage.
ESG considerations can have a direct impact on a bank’s financial performance. Banks that prioritize ESG factors are more likely to attract socially responsible investors and customers, which can enhance their reputation and improve their access to capital. Additionally, banks that have a strong ESG focus are better positioned to manage risks associated with environmental, social, and governance issues, which can help to mitigate potential financial losses. By incorporating ESG factors into their lending decisions and investment strategies, banks can also identify new business opportunities and support sustainable economic growth.
Another impact of ESG on the banking sector is on reputation and brand value. Banks with poor ESG performance may face reputational damage, which can lead to a loss of customers and investors. On the other hand, banks that demonstrate strong ESG performance can differentiate themselves from their competitors and attract customers and investors.
Furthermore, ESG considerations can impact banks’ risk management practices. Environmental risks, such as climate change, can have a significant impact on banks’ loan portfolios. Banks that are exposed to environmental risks may face losses if they do not manage these risks properly. Therefore, banks need to incorporate ESG considerations into their risk management practices to limit their exposure to environmental and social risks.
Benefits of ESG Norms:
(i) ESG reporting norms (like BRSR Guidelines) are likely to play a bigger role in how companies are assessed, not only by investors but by consumers and stakeholders.
(ii)The ESG frameworks are heading towards standardisation, which would reduce the scope of misrepresentation and greenwashing.Greenwashing is the act of giving a false image or giving false information about how an organisation’s products are more environmentally friendly. It is the practise of making unsupported claims about the environmental friendliness of a company’s products in order to mislead customers.
(iii)BRSR Guidelines will bring in more transparency in ESG reporting. This will attract greater investments in socially-responsible and environmentally-sustainable companies. This will prompt corporates to adopt sustainable measures.
Challenges with ESG Reporting Norms:
- Methodological data issues: There are major problems with the data that is being generated by organizations today, including lack of verification, difference in the manner in which data is collected by corporations and then subsequently reported. Generally, it creates a lack of faith by investors in quality of that data therefore it becomes difficult to make investment decisions.
- Lack of standardization: As a norm, organizations assess environmental and social information in order to put it into financial audit reports. There is relatively less reference to standard for reporting, disclosure and materiality outside of sustainability reports.
- Constantly evolving reporting requirements: Due to the constant changes in political landscape, reporting framework continues to evolve with the changes in legislations, it becomes difficult for organisations to cope up with the changing reporting requirements.
- The impacts of ESG measures are difficult to quantify. While the financial performance of companies can be measured accurately by defined financial metrics (like profits after tax, return on assets/investments), such metrics are difficult to be defined for ESG measures. This make it difficult to measure comparative performance of corporates on sustainability measures
The banking sector has an important role to play in promoting sustainable economic growth and social progress. By prioritizing ESG considerations, banks can enhance their reputation, manage risks, and identify new business opportunities. ESG factors are increasingly becoming a critical consideration for investors and customers, and banks that fail to incorporate ESG considerations into their operations may face significant financial and reputational risks in the long term. As such, it is essential for banks to embrace ESG factors and incorporate them into their decision-making processes to ensure their long-term success and sustainability.
Robust ESG framework and responsible ESG investing are very important for an emerging economy like India as it provides an opportunity for all stakeholders to build an economy that is financially, socially and environmentally sustainable. SEBI has facilitated the achievement of the United Nations Sustainable Development Goals and the Paris Agreement on Climate Change by way of mandatorily requiring ESG reporting by Indian companies.
Going forward, the ESG norms can be extended in their scope and applicability to include the unlisted companies as well.