Hong Kong banks must do more to reduce their impact on climate change, not just avoid risk

This article appeared originally in the South China Morning Post on 20 Aug, 2020.
Authors: Johnson Kong, researcher, and Serena Chow, assistant researcher at Our Hong Kong Foundation

The Hong Kong Monetary Authority recently released a white paper on green and sustainable banking. Amid the economic gloom of Covid-19 and the global trend towards sustainability, the regulatory authority is taking an admirable step in making the city’s banks more sustainable. Praiseworthy as it is, though, the question remains how much the kind of banking envisioned in the paper will contribute towards environmental and social sustainability, if at all.

The primary focus of the paper is on “the risks posed by climate change to banks”. Climate change could generate significant risks to banks’ portfolios, such as farm loans not being repaid because of poor crop yields following droughts or utility companies defaulting amid new legislation on carbon emissions. Making sure banks stay strong is certainly important for the HKMA as a banking regulator.

Focused on four key areas – governance, strategy, risk management and disclosure – the HKMA sets out its initial supervisory expectations on how banks should build resilience to climate-related risks. For example, it prompts banks to gauge how their portfolios would be affected under varying scenarios of temperature rises in the future.

However, building a resilient banking system is not the same as fostering environmental and social sustainability, despite overlaps in some areas. To contribute towards sustainability, banks would need to manage their environmental and social impact as well as risks.

In the case of climate change, managing climate risks concerns how climate change affects the banking system, whereas managing the impact relates to how banking activities influence the climate, especially through the economic activities they finance. The latter would, for instance, require banks to cease financing coal power and provide more capital to renewable energy projects.

Unfortunately, banks’ environmental and social impacts take a back seat to risks in the HKMA’s new supervisory expectations. To be fair, the regulator does encourage banks to develop sustainability-related business, but the regulatory focus remains on climate-related risks.

In other words, banks are not really expected to manage their impact on climate, biodiversity or human rights as long as that impact is not financially material to them, which falls short of the United Nations’ Principles for Responsible Banking.

While taking it one step at a time is a reasonable strategy, banks’ management of their environmental and social impact should at least be incorporated into the regulator’s strategic agenda. Failure to manage these impacts, even if it does not constitute direct financial risk to individual banks, is likely to accelerate risks to the banking system.

For example, a recent article published in Science suggests that reducing deforestation can help prevent the next devastating pandemic as deforestation is linked to the emergence of novel animal-to-human diseases previously contained in forested areas. Banks should be expected to consider whether the project or company they finance is associated with rampant deforestation, even if the direct financial risk is minimal.

Meanwhile, banking regulators worldwide are ensuring banks pay attention to their sustainability risk and impact. Like the HKMA, they have set their supervisory expectations with a spotlight primarily on building resilience.

Those expectations are not the only regulatory framework for banks in their jurisdictions, though. For example, large banks are already mandated to disclose sustainability-related information under the Non-Financial Reporting Directive, a law regulating all large companies operating in the European Union.
More importantly, it is not only about sustainability risks. The EU directive also requires large banks to make known their impacts on the environment and society, something omitted in the HKMA framework. For example, it urges banks to consider disclosing information about their lending portfolio contributing to climate change mitigation and adaptation.

Closer to home, the China Banking and Insurance Regulatory Commission has developed one of the most comprehensive sets of mandatory regulatory requirements covering banks’ management of environmental and social risks, as well as environmental impact.
It looks at the sustainability-related governance structure, strategy, management and disclosure the banks have in place, as well as paying close attention to how much money banks lend to green projects. Banks are scored on these aspects, which motivates them to better manage sustainability risks and contribute to sustainable development.
Looking at Hong Kong, its latest supervisory expectations for banks are found wanting in comparison to other economies’ efforts. For Hong Kong’s sustainable banking to live up to its name, more consideration should be given to banks’ management of their environmental and social impact so we can mitigate the sustainability risks facing our economy and banking system.