Building an ESG-focused database is a massive task for both banks and customers

The European Union Member States have set themselves the goal of achieving full climate neutrality by 2050, with an EU-wide proposal to reduce greenhouse gas emissions at least 55% by 2030 compared to 1990. Accordingly, Hungary is also committed to climate neutrality and has similarly ambitious sustainability targets, although it is estimated that more than 10 000 billion forints will be necessary to achieve them.

These targets are expected to be supported by several Hungarian and EU funding projects as well as central bank incentives. Meanwhile, the banking sector will also have a key role in promoting sustainable financing objectives in the forthcoming years. This requires a review of several aspects of current banking operations, from strategy development to communication, as well as banks' ability to identify the needs of consumers and their own conscious efforts to develop sustainable products and services for both retail and corporate clients.

There are promising domestic initiatives and several international cutting-edge solutions for green product development. In this respect, one of the first and most significant steps is the Green Home Program launched by the Hungarian National Bank (MNB), which aims to enable banks to offer loans at a much more favourable interest rate – up to 2.5% – than currently available on the market. This is available from October 2021 to retail customers who are considering building or purchasing a new home with an energy rating of BB or better and a primary energy demand of 90 kWh/m2/year or less.

Alongside the MNB, domestic financial institutions are also making a strong effort to develop green products that are in high demand among corporate and retail clients. For example, several financial institutions already have retail bank accounts that include a recycled bank card, or automatically support foundations, associations and non-profit social organisations that serve priority social causes through their work. Examples of such organisations include:

• Emphasized task of the Foundation for Children with Tumorous Diseases (Együtt a Daganatos Gyermekekért Alapítvány) is to support the hospitals of Hungarian Pediatric Oncology Network with the available sources.
• The Shelter Foundation (Menhely Alapítvány) is using grants to help work against prejudice against the dignity of homeless people.
• The primary goal of the Forest Rescue Foundation (Erdőmentők Alapítvány) is to protect forests and wildlife and restore their damage.
• Supporting the activities of The National Hungarian Beekeeping Association (Országos Magyar Méhészeti Egyesület), which spends money on rescuing bees and thus ensuring their role in maintaining ecological balance.

The range of green investment products is also varied, in addition to many investment funds, we also find green government bond and green treasury products in the domestic market. These are characterized by the fact that they are supporting investments in projects that promote environmental and social sustainability and in shares of companies operating in “green” industries.

However green loans are not yet widespread in Hungary compared to Western trends, financial institutions already finance several sustainability goals, even if they are not officially labeled "green". In Hungary currently the focus is on financing of large companies’ green projects (e.g. the purchase of energy-efficient commercial real estate), which may be followed by the development of products that are attractive to SMEs. On the retail side, mortgage loans are expected to become more widespread soon, which may be followed by unsecured green loans, but this area is not yet matured. Currently, the most common supported green loan targets in domestic banking are:

• investment loans and project loans financing green goals (e.g. establishment of solar parks, purchase of energy-efficient commercial real estate and promotion electromobility);
• personal loans for energy modernization (e.g. construction of solar installations, heating modernisation and car charging stations);
• retail green leasing products, which focus primarily on promoting electromobility, in particular by financing vehicles with zero direct CO2 emissions;
• issuance of corporate bonds for green investment and development purposes, which typically target green energetic developments, construction of green buildings, improvement of water management and wastewater treatment systems, sustainable transportation and energy efficiency.

Exploring international banking practises we can find even more promising green solutions:

• there are also universal banks in the German and British markets that offer housing loans at an attractive interest rate when buying a new, energy-efficient home. To benefit from the discount, the customer must prove that the energy efficiency rating of their property is better than ‘81’ (on 0-100 rating scale) or ‘B’ (on A-G rating scale) based on the local energy certificate ratings; or that the final energy consumption of the building does not reach 75 kWh per square meter;

• We also find significant international activity in the development of green corporate products, typically in the Scandinavian countries, Finland and the Netherlands. Financial institutions in these countries offer attractive interest rate schemes to finance corporate activities focusing on reducing energy consumption, sustainable use of natural resources, waste management and wastewater treatment systems, water treatment (e.g. investment in clean drinking water and household water), electric vehicles and public transportation;
• In addition to corporate loans, special bonds have appeared on the international market, where proceeds are used to finance projects involving social engagement (social bond) or a combination of green and social projects (sustainability bond), or in which the interest rate also depends on the fulfilment of a predefined ESG target / performance indicator (sustainability linked bond).

The role of financial institutions is outstanding in achieving sustainability goals, as banks are able to influence economic actors through their lending activities, along the financing conditions, to steer their activities towards sustainability. Therefore, a key element of sustainability strategies of banks should be to restructure their lending processes, to avoid greenwashing by demonstrating that resources are indeed being spent on green lending. Compliance with ESG criteria is currently assessed according to different methodologies, as there is currently no generally accepted guideline on exactly which loan targets are considered green. To define this, uniform regulations at international level is under preparation, such as the EU Taxonomy, which already provides guidance on this issue by sector and activity, along specific indicators.

Industry experience shows that the whole credit risk underwriting and management process needs to be adapted to the tightening sustainability requirements. Experts agree that one of the main challenges in the ESG-enhanced lending process is the need to rethink and reform customers’ reporting practices. During the due diligence and risk assessment, clients of financial institutions need to share such data that may have never been measured before, or at least not collected in a structured way. For example, the company's direct and indirect carbon emissions, the proportion of hazardous waste generated, the breakdown of number of employees and salaries by gender and age group, or the demonstration of the number of official environmental procedures will become a basic requirement in the near future. This information will be essential for credit risk assessment, preparing credit ratings and making lending decisions, that will influence pricing practices. When assessing ESG (Environmental, Social, Governance) risks and integrating them in pricing, the following indicators and KPIs may be worth considering:

It already can be seen that building-up an ESG-focused database is essential for financial institutions because their own databases are typically not appropriate to prepare analyses and reports about sustainable development. In the future this will be a huge challenge for both clients and financial institutions, however there can be several possible solutions:

• Existing data can be supplemented with data from sustainability reports of companies, but only a small proportion of industrial players prepare a comprehensive, quantified reliable report on a regular basis.
• Request for data from customers can improve the extent of the current ESG database, but this probably has a negative impact on the customer experience.
• It can be particularly a great challenge for customers to comply with different reporting practices for all financial institutions, so it may be worthwhile to take steps towards standardization and create a central database (for example similar to company information databases) that could also improve data quality and reliability.
• International ESG data reporting service and rating companies already offer complete service packages, but typically still focus on listed companies.
• There are some international solutions that use artificial intelligence to collect and analyse large amounts of publicly available data (e.g. from online news portals, social media), but this is not a common practice yet.

The sustainability goals are challenging for all stakeholders, but in addition to the difficulties, these processes can also be interpreted as a future opportunity. In addition to PR considerations, new business opportunities appear for financial institutions and companies that take ESG into account, as new products, industries and attractive financial resources become available. Furthermore, ESG considerations are becoming increasingly important in stock market investment decisions. It will be worth monitoring these trends in the future, as those who act in time will be able to take advantage of the opportunities.

Authors: Eörs Huba, Bálint Palotai