Society is rightly focused on the impact of climate change. The steps we, as individuals, countries and organisations, can take to mitigate and hopefully in the long run alleviate climate risks are hugely important. A bank is no different, whilst they do not obviously consume fossil fuels in a manufacturing process, they do finance the industries that do. A bank treasurer can play a crucial role in influencing sustainable lending through an efficient Funds Transfer Pricing (FTP) process. FTP is a mechanism used by banks to allocate funding costs and earnings to various business units and is based on their contribution to the overall financial performance. By incorporating sustainability metrics into the FTP process, treasurers can incentivise and promote sustainable lending practices arguably more efficiently than any other area in the bank.
Here's how:
1. Cost of Funds Allocations & Risk Adjusted Pricing:Integration of Sustainability Metrics: The treasurer can incorporate sustainability metrics when determining the cost of funds for different business units. Business units that engage in sustainable lending practices, such as financing green projects or supporting environmentally friendly initiatives, can be allocated funds at a lower cost. This creates a financial incentive for business units to prioritize sustainable lending. Consideration of Environmental, Social, and Governance (ESG) Risk in Pricing Models: The treasurer can integrate ESG risk factors into pricing models used for FTP. Sustainable lending practices that align with positive ESG outcomes can be reflected in more favourable pricing, encouraging business units to incorporate ESG considerations into their lending decisions.
2. Profitability Adjustments:
Linking Sustainability Performance to Profitability: The treasurer can introduce adjustments to profitability calculations based on the sustainability performance of lending portfolios. Business units that actively engage in sustainable lending practices and contribute to positive environmental and social impacts can see enhanced profitability within the FTP process. This aligns financial incentives with sustainability goals.
3. Incentivising Sustainable Loan Growth:
Differential Funding Costs for Sustainable Loans: The treasurer can establish a tiered funding cost structure, providing lower costs for funds allocated to sustainable loans. This encourages business units to focus on growing their portfolios with sustainable lending products, as it becomes financially advantageous for them to do so.
4. Transparency and Reporting:
Communicating Sustainability Impact: The treasurer can ensure that the FTP process includes transparent reporting on the sustainability impact of different business units. This visibility not only promotes accountability but also allows stakeholders to understand how sustainable lending practices contribute to the overall financial health of the bank.
5. Alignment with Corporate Strategy:
Embedding Sustainability Goals in FTP Objectives: The treasurer can ensure that the FTP objectives align with the overall corporate sustainability strategy. By explicitly linking FTP goals with sustainability goals, the treasury department reinforces the importance of sustainable lending within the broader organisational framework.
6. Collaboration with Risk Management:
Integrating ESG Risk Assessments: Collaborating with the risk management function, the treasurer can integrate comprehensive ESG risk assessments into the FTP process. This ensures that the cost of funds reflects not only financial risks, but also environmental and social risks associated with lending activities.
In summary, a forward-thinking treasurer can leverage the FTP process as a powerful tool to drive and influence sustainable lending within a bank. Of course, the bank itself, it’s governing body and shareholders must drive such initiatives from the top of the organisation, cognisant of both impact to overall returns and the sustainability profile of the organisation in the eyes of investors and society. However, this objective is becoming more and more of a hygiene factor across all industries including banking. By aligning financial incentives with sustainability objectives, the treasurer contributes to creating a holistic approach where financial success goes hand in hand with positive environmental and social impacts.
