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Incorporation of Environmental Issues into Banks’ Lending Decisions

This thesis examines commercial banks’ practice pertaining to the integration of environmental issues into their lending activities. There is evidence that over the last few decades some banks have considered the environmental impact of borrower activities as part of credit risk assessment and management. A number of academic surveys have identified a positive correlation between the environmental and financial performance of companies. These developments influence the level of bank support for responsible environmental management. For most commercial banks loans are a large percentage of assets. Hence appropriate management of loans is a priority for bank management, shareholders and other interested people. Traditionally, banks use financial instruments to measure the efficiency of their lending decisions and to ensure that payments are made on time. However, each lending operation may involve environmental risks. Adverse environmental outcomes may result in a reduction in the borrowers’ repayment capacity, a decline in the value of the collateral, a direct bank liability for environmental damage caused by its borrowing clients and potential risks to the bank’s reputation. For each of these risks the bank can determine the likelihood, extent, cost and impact should the damage actually occur. Bank lending occurs in a wider economic and social context of strategic importance for banks. Society’s quest for sustainable development involves the creation of new financing markets, such as markets for sustainable energy, water purification equipment, products for the financing of companies’ climate policies and groundbreaking technology. Banks can fulfil the role of a traditional financial intermediary or can step into this growing market to develop specific new products such as environmental loans. This market is rich in challenges and opportunities. Hence, it is crucial that banks have appropriate indicators to help them and stakeholders monitor performance. Against this background, this study investigates the practice of incorporating environmental issues into banks’ lending decisions, utilizing Westpac as a case study. Qualitative and quantitative research approaches were adopted. A mixed method of data collection was used, consisting of an analysis of annual reports, semi-structured interview and a survey questionnaire. The Westpac study is used to develop and test an environmental sustainability framework to analyse the incorporation of environmental issues into lending decisions by financial institutions. The results from the research provide some evidence that Westpac incorporates environmental issues into lending decisions and is aware of environmental risks and opportunities. At the operational level, the bank assesses environmental risks before approving loans and finances projects with high environmental benefits. With regard to motivational drivers, the findings indicate that the bank’s incorporation of environmental issues into lending decisions is motivated by multiple reasons: managerial, financial and environmental. However, the environmental information reported was not consistently and sufficiently communicated to stakeholders. Further, the results from the research reveal that bank management should effectively consider environmental issues when making lending decisions and that they should take specific actions to have such issues effectively implemented. Although banks are motivated by a variety of factors, financial issues were considered the most important factor when banks are making lending decisions. This study also reveals that respondents did not know about bank effectiveness in addressing environmental issues when making lending decisions. Moreover, people who are likely to be better informed or knowledgeable about environmental issues were also found to have a low level of knowledge in this regard. Furthermore, the majority of respondents tend not to be satisfied with the interaction between banks and both the public and the New Zealand government. The literature to date suggests there is increasing stakeholder pressure on businesses to act with environmental responsibility, but this result suggests challenges still remain. A comparison of Westpac and HSBC stakeholder reports revealed that HSBC provided more appropriate environmental information than Westpac regarding their lending activities. The comparison reveals that there is a shift in how banks view the consideration of environmental performance as material to users of the annual reports. However, there is a gap in the information provided probably due to the voluntary nature of sustainability disclosures in annual reports. Thus, there is a need for improvement relating to the content and quality of environmental reporting. This research proposes an environmental sustainability framework, with specific focus on the lending process as a guideline for bank management, policy makers and other interested people. It facilitates effective measurement of environmental performance in two major areas: management and operations, and motivations. The framework includes indicators and processes to improve bank financial and environmental performance. The key findings of this study are instructive. Consideration of environmental issues when making lending decisions is important to banks, borrowers, the environment and stakeholders in general. Environmental risks, opportunities and the positive relationship between the environmental performance and financial performance give motivation to integrate environmental issues into lending activities. This study identified that Westpac and commercial banks more generally have an opportunity to provide further and consistent evidence concerning their managerial and operational performance and drivers when making lending decisions. Such actions would provide stakeholders with more accurate views on the bank’s environmental performance. It would also facilitate the bank’s ability to respond sufficiently and transparently to the international agreements and initiatives the bank is signatory to and/or a member of.
Type of thesis
Mazahrih, B. J. S. (2011). Incorporation of Environmental Issues into Banks’ Lending Decisions (Thesis, Doctor of Philosophy (PhD)). University of Waikato, Hamilton, New Zealand. Retrieved from https://hdl.handle.net/10289/5885
University of Waikato
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