The place of sustainable development in ESG risks formation in banking sector

Abstract

Environmental, social and governance (ESG) issues as well as related opportunities and risks are becoming increasingly relevant for financial institutions. For banks, sustainability is not only an ethical issue, but may soon become an economic and existential one, generating a new kind of risk - ESG risk. Banks must approach ESG risk in a comprehensive way by incorporating it into their risk management systems. This process includes adjusting business and risk strategies, and related risk appetite statements, as well as ensuring full transparency. While ESG risk is not a completely stand-alone type of risk, it affects financial and non-financial risks present in the bank to varying degrees. Consequently, risk management methods and processes must be modified to take into account the complex causal relationships between risk types. This involves the use of risk measurement/assessment techniques in the bank management and change processes, as well as in stress testing. In addition to incorporating ESG into the risk framework, banks need to consider related issues in product development, pricing, and sales decisions. In addition, proper consideration of ESG risks in a wide range of change processes is vital to improving profitability. Regulators, rating agencies and other parties around the world are showing increased interest in this topic, leading to increased reporting requirements and needs. This constant stream of new regulations poses serious compliance challenges for banks. This paper explores these issues. It examines ESG factors and sustainability issues in the banking sector, highlights the opportunities to embed these considerations throughout the risk management process, and provides parallels that can be used to learn from the COVID-19 crisis. This article proposes a holistic approach to ESG risks in risk management.