Pandemics and environmental risks are viewed as similar in terms of impact, representing an important wake-up call for decision makers. Mohamed Dabo reports

Since the concept of sustainability was introduced into the financial sector, a new type of risk has been emerging: sustainability risks, also referred to as environmental, social or governance (ESG) risks.These focus on the potential effect an organisation’s stakeholders – such as customers, outsourcing suppliers, employees, or the environment – may exert, and in reverse, the impact that the organisation may have on its stakeholders and the environment due to its activities.When occurring, ESG risks will or may have negative impacts on assets, the financial and earnings situation, or the reputation of a bank.As it turns out, there are interesting similarities between Covid-19 and ESG risks.

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Covid-19 has much in common with ESG risk
Thus, an unexpected opportunity opens up in observing the current crisis: Banks can leverage the (unfortunate) experience with Covid-19 to better cope with future ESG risk challenges.Similar to ESG risks, Covid-19 creates various effects and risks that affect banks at different levels.To begin with, banks are directly affected – akin to physical ESG risks – by Covid-19 via, among others, the following factors:

  • Higher sickness rates leading to a reduction in workforces;
  • Shutdowns in various countries, territories and states, which largely requires homeworking, leading to friction;
  • Travel bans hindering international business;
  • Issues with network capacity, cyber-risk and IT security.

These developments are particularly effective in the operational risk area, much like ESG risks. They can also exert additional impact on reputation, in case stakeholders’ expectations are not fully met, even after discounting for some crisis-induced goodwill.

Subsequently, business and liquidity risks are likely to surface, while demand for some banking services can decrease and customers can withdraw deposits.

The impact of change depends heavily on the industry

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Bank clients are often hit even harder by the crisis, depending on the industry segment they operate in.In addition to the points above, issues that clients face include:

  • Government orders to shut down various businesses, such as restaurants, for an undefined period;
  • Breakdown of supply chains, hitting global suppliers particularly hard;
  • Massive decrease in demand, domestic and abroad.

Outside-in effects, which in turn affect banks due to the issues mentioned, can be noticeable through an increase in defaults.

These are expected to occur both in commercial as well as in retail banking, such as due to clients becoming unemployed. Also, an impairment of assets, including collaterals, must be expected because, for example, commercial real estate is difficult to rent in times of crisis.

Not only clients are negatively affected by Covid-19 however; the same can happen to outsourcing partners and suppliers of banks. In this case services are expected to be of reduced quality or fail completely.

Finally, similar to the transition risks that are described in connection with ESG risks, governments are exerting extensive influence on people and business.

This again both is expected to affect banks directly – if, for example, employees are put in quarantine – as well as their clients and suppliers – if, for example, additional business segments are forced to close.

The main difference between the Covid-19 crisis and ESG risks is in the relevant time frames.

While ESG risks are subject to a multi-year, largely transparently planned transition, interventions in the Covid-19 crisis are changing almost daily, with little predictability, forcing banks to adapt quickly to changing, unpredictable environments.

In the current pandemic, banks can only react quickly, mostly in an ad-hoc manner

However, if banks also use the crisis to investigate direct and indirect effects of external triggers, they can plan for similar transmission channels for future ESG risks.Banks’ ability to cope with Covid-19 as well as with ESG risks largely depends on their level of maturity in terms of operational resilience.Frameworks for operational resilience are designed not only to preserve business continuity, but also to enable organisations to permanently adjust to changing conditions.Investing in those frameworks can pay off in multiple ways.