LARGE-SCALE disruptions over the past two years, on top of the global pandemic, revealed the need to take significant initiatives now while action can still make a difference. Our own Bangko Sentral ng Pilipinas (BSP), for one, has been busy fortifying the entire financial system against risks arising from environmental and social (E&S) issues.
Over the past two years, the BSP has released three issuances on Sustainable Banking — BSP Circulars 1085, 1128, and 1149 — to guide financial institutions as they integrate E&S risks into their corporate governance, risk management methodologies and frameworks, implementation of business strategies and decisions, and policies.
BSP 1085, or the Sustainable Finance Framework, provides foundational guidelines for establishing an environmental and social risk management system (ESRMS). This issuance includes:
• the duties and responsibilities of the Board of Directors and senior management to institutionalize the adoption of sustainability principles in the bank; and,
• guidance on the management of E&S risks and embedding these in existing documents and protocols.
BSP 1128, which focuses on Environmental and Social Risk Management Framework, amended BSP 1085 and governs E&S risks’ integration into the bank’s risk management framework. This issuance includes:
• the duties and responsibilities of the Board of Directors and senior management in managing E&S risks and integrating these into the bank’s Credit Risk Management System (CRMS) and Operational Risk Management System (ORMS); and,
• a comprehensive list of requirements and guidelines for the integration of E&S risks into the bank’s CRMS and ORMS, including: policies, procedures, and processes; risk identification and assessment; risk monitoring and reporting, and, risk control and mitigation.
BSP 1149 contains guidelines on the integration of sustainability in investment activities of banks. It amended BSP 1128 to include the integration of E&S risk management into investment activities. This issuance includes:
• the duties and responsibilities of the Board of Directors and senior management in integrating E&S risks into the investment activities of the bank; and,
• a comprehensive list of requirements and guidelines for policies, procedures, and limits, and integration into the bank’s Risk Measurement, Monitoring, and Management Information Systems (MIS).
In addition to these, the BSP released Memorandum No. M-2022-042 on Oct. 3, to provide guidance on the implementation of the ESRMS. Under this issuance, the BSP expects banks to:
1.) define the roles of the Board of Directors and senior management in institutionalizing and overseeing the adoption and implementation of sustainability principles in the corporate governance, risk management frameworks, and strategic objectives and operations of the bank;
2.) define the level of their risk appetite regarding E&S risks;
3.) provide clear guidance in assessing E&S risks in the bank’s operations, products and services, transactions, activities, and operating environment;
4.) provide the tools for monitoring E&S risks and assessment;
5.) provide the measures that should be taken in case of breaches of limits or thresholds or non-compliance with sustainability-related standards, laws, and regulations;
6.) integrate E&S risks into stress testing exercises covering short- and long-term horizons; and,
7.) identify the unit or personnel responsible for overseeing the management of E&S risks and provide sufficient capability building for the key department units.
Altogether, what do these BSP issuances mean for banks?
Banks need to go beyond understanding the direct impact of E&S risks on their operations and, instead, consider as well how these risks impact the country’s macroeconomic and microeconomic conditions, which will also indirectly affect them. For example, environmental risks such as extreme weather events and rising sea levels could damage borrowers’ facilities in high-risk areas. These damaged properties may be significantly destroyed or rendered unusable. The bank will be directly affected due to the risk of devaluation of the borrower’s collateral and the increased risk of defaults caused by disrupted operations.
Banks must set clear criteria for assessing E&S risks, given how these factors can affect the bank at the macroeconomic level. They must also have a clear risk appetite and internal guidelines on what management approach they must expect from clients for each identified E&S risk.
Lastly, banks need to conduct stress testing to quantify the implications of identified E&S risks to their credit risk.
On the part of Philippine companies looking to raise capital through loans, they must be ready to identify their exposure to E&S risks based on their industry and geographical location and set up their E&S management system based on the requirements of banks they transact with.
To facilitate compliance with these issuances, the BSP can collaborate with the Climate Change Commission and make the information on projected climate risk characterization in different climate futures accessible to the public. Banks, on the other hand, can consult with E&S experts to better understand these critical risks and seek guidance on the risk assessment that will inform how they set their risk appetite and risk controls.
Overall, the BSP’s most recent issuance provides more explicit guidance on how banks should set up their ESRMS. It also offers a better policy framework that sets a level playing field, so that banks that do well in managing their E&S risks do not necessarily become less competitive in the market.
A strong financial system goes hand in hand with impactful sustainability practices. The BSP’s transformational policy will accelerate the green transition of our country’s finance sector and pave the way for banks to play key roles in building a more sustainable and resilient Philippine economy.
Mariam Hazel Pugoy and Bonar Laureto are part of the Climate & Sustainability advisory team within the Risk Advisory group of Deloitte Philippines (Navarro Amper & Co.), a member of the Deloitte Asia Pacific Network.