Latin American banks hone socially responsible lending policies
March 7, 2018 |
Latin America’s banks are stepping up to address environmental issues and other social matters in their lending policies. But financiers and investors say long-term profits are also at stake.
An alert sounding at Sudameris Bank in Asunción, Paraguay warned that a client’s cattle farm 250 kilometers away was on fire. The midsize bank, which had just begun using a satellite tool to keep closer tabs on its credit portfolio, notified the client, who was unaware of the fire until then.
A few days later, the client sent a note to say thanks. The 2016 fire cost him 100 hectares of pasture, but the rest of his 1,200-hectare property — and, importantly, his herd — was fine. Rather than viewing the bank’s vigilance as an invasive overreach, the rancher was impressed that Sudameris was looking out for him.
Sudameris’ use of Global Forest Watch, an online platform spearheaded by the nonprofit World Resources Institute (WRI) that pinpoints fires and fallen trees in real time, is an example of how banks in Latin America are getting creative to make financing more sustainable.
“We have a more integral valuation of the client,” says Omar Fernández, head of risk for Sudameris. “It used to be just financial. They can no longer fool us. We can tell if they’re using the area they say they are using, thanks to the satellite.”
Paraguay’s economy depends heavily on agriculture — it is the world’s fourth-largest soy exporter and the sixth-largest beef exporter. Many banks in Paraguay have come to recognize the role they can play in supporting sustainable agriculture, so that the country’s growth engine keeps chugging along.
In 2012, a handful of private sector banks that operate in Paraguay — including Sudameris — came together to create the Mesa de Finanzas Sostenibles, a voluntary collaborative platform to help manage social and environmental risks. Today the Mesa covers more than 80% of the credit granted in Paraguay.
The sales department at Sudameris was initially reticent to cooperate with tougher standards. They did not want to bother clients for more documents and they worried about losing clients to competitors with more lax lending standards, Fernández says.
But in Fernández’s view, the bank has an obligation to corroborate — to the best of its ability — that clients and potential clients are complying with the law by securing environmental permits, for example. A loan to support the exports of timber from endangered trees would turn the bank into an accomplice in the illicit activity. The potential reputational damage is just not worth it, he says.
The WRI is tailoring its monitoring tool to attend the specific needs of banks. The upgraded version, called GFW Pro, should be ready later this year. GFW Pro will allow multiple bank employees — from the commercial team to risk officers to credit committee members — to access information that will help a bank evaluate risks at the project level and in the whole portfolio as it evolves over time.
GFW Pro will be free to users. “Our objective is to help the banks mitigate their risks and, by doing that, create positive impacts,” says Luiz Amaral, global executive manager for Global Forest Watch Commodities and Finance.
Some environmental and social risks are easier to quantify than others. Violations of environmental rules can result in financial penalties, for instance, such as when Santander’s business in Brazil received a fine for 47.5 million reais ($14.7 million) in 2016 for financing soy plantings in protected areas of the Amazon.
But the financial impact of reputational damage can be more subtle, and lax due diligence can also prevent banks from collecting collateral if a client plants crops on disputed land claimed by indigenous peoples or in national parks.
Luiz Gabriel Todt de Azevedo, division chief for environment, social and governance at IDB Invest, says banks need to strengthen the case both internally and externally with clients that sustainability practices can lead to higher returns in the long run.
Sustainable investing strategies tend to favor less volatile, competitively advantaged and financially healthy companies. A 2017 Morningstar analysis showed that funds with sustainable criteria tend to outperform their regular peers over the lifespan of those investments.
The S&P 500 Environmental and Socially Responsible Index, which measures the performance of S&P 500 companies that meet environmental and social sustainability criteria, posted total returns of 25.6% last year versus 21.8% for the S&P 500 overall.
“Banks have come to realize that financial performance is correlated with environmental social governance,” Azevedo says. Some banks, however, have left a lot of room for improvement, he says.
“For some banks, it’s hard to perceive which is the short-term, unsustainable gain versus the long-term, more reliable gain. That tradeoff plays out not only at the institutional level but also at the individual level. Incentives, in terms of rewards, are not related to how the bank grows in 10 years. It’s how much you make this year. Some of these incentives need to change,” Azevedo says.
Regulators can play a big role in driving change and leveling the playing field for banks that want to enforce stricter sustainability requirements. Whereas the gravitational shift toward shared sustainability practices in Paraguay has been largely driven by the banks themselves, Brazil’s central bank has required banks to have social-environmental policies and due diligence processes in place since 2014.
The Brazilian division of Dutch lender Rabobank saw the need for tighter sustainability requirements when it began lending to the agricultural sector in 2005, according to Thais Zylbersztajn Fontes, the bank’s corporate social responsibility manager. Rabobank Brasil felt the sector was rife with potential problems, due to deforestation, labor violations and land rights disputes with indigenous communities. “We need to be careful with who we work because we can be co-responsible,” Fontes says.
The bank drafts a detailed questionnaire that its technical agents send to the properties of each prospective rural client and then inspects client properties every year. By incorporating the information into its models, Rabobank prices sustainability drivers into longer-term portfolio risks and returns. The better the sustainability score, the lower the client’s interest rate.
“Once they see they can have a better interest rate, they want to do that,” Fontes says.
The questionnaire has evolved over time from simple yes or no answers to an application with 58 questions that require more details. Meanwhile, Rabobank’s customer base has grown to include 1,200 rural clients that produce a wide range of commodities, from livestock to sugar, coffee, cotton, soy and pulp.
Rabobank has continued to innovate. In 2017, it created a lower interest rate “green loan” to motivate clients to use solar energy. So far, only two clients, both soy farmers, have taken advantage of the program as nervousness over the direction of the Brazilian economy has stymied investment plans.
Itaú Unibanco also integrates sustainability principles in its operations. “Our vision is to be a leader in sustainable performance,” says Denise Hills, head of sustainability and inclusive businesses at Brazil’s largest private-sector bank.
“We are trying to think about long-term questions such as climate change,” says Rafael Burini Ohde, head of retail credit risks at Itaú.
This longer horizon has led the bank to prioritize financing for projects with the potential to support a low-carbon economy, such as wind and solar energy projects. The bank minimizes its exposure to the oil and gas sector, while financing for gambling or weapons is strictly off limits. “We have some sectors that we don’t want to expose the bank to,” Burini says.
Of course, there are gray areas. Banks face dilemmas when it comes to aircraft manufacturers who might sell to militaries or in conflict zones. Itaú places numerous conditions on such clients, such as specifying that financing be used strictly for commercial aircraft.
A history of major labor violations is another deal breaker. Itaú has rejected potential clients in the agribusiness and clothing manufacturing industries for having apparently engaged in modern-day slavery.
Additional activities, such as fishing, forestry, cattle ranches and infrastructure projects, require a more thorough analysis. The bank relies heavily on public records, with site visits as warranted. The research process may include consultations with a wide range of experts, including biologists, environmental engineers, and even psychologists and anthropologists. In the long run, it is more expensive to get involved in a bad project than to spend the extra effort and expense on rigorous due diligence.
Bianca Zambão, the environmental and social risk coordinator at Itaú, recounts how the bank did extra homework ahead of a port project that identified a potential impact on a nearby community. The bank incorporated this consideration into the credit agreement. When the community later protested the port, the local concerns were addressed within weeks.
By carefully detailing social and environmental requirements into credit agreements, banks have the option of refusing disbursements when a client falls out of compliance.
“We can only enter into projects when we really understand that the client is capable of managing environmental and social risks. Not only capable of, but also willing,” Zambão says. LF