When ESG becomes an innovation opportunity for banks

Innovation leaders regularly get asked: How will the banking industry change in the next three to five years?

This question is more relevant than ever as banks, and the rest of the world, cope with multiple, unprecedented crises that will have profound, long-term societal and corporate impacts—yet to be determined. The through line intersecting most of these pressing concerns is environmental, social, and corporate governance (ESG).

It’s a mistake to see ESG as solely being shaped by the compulsory demands of regulation. Instead, I argue, it’s the evolving public and investor sentiment around environmental and ethical practices that is the real driver of how ESG advances. Banks that remain unresponsive chance significant reputational risk.

Further, the banks that will be best positioned to navigate and fulfill new customer and investor expectations are those who leverage digital transformation as a way to both evaluate and enable ESG fulfillment.

Zeitgeist 2020

2020 gave us numerous examples of how people are becoming increasingly concerned with social and environmental issues. Think:

• The Black Lives Matter movement, with its passionate call for equality among all people, starting with the ones who are hurting most;
• The international pandemic, which highlighted underlying class and economic fissures—including relief for displaced workers and protections and pay for essential, frontline ones; and
• The vulnerability of societies and enterprises to volatile natural events, such as the unprecedented intensity of climate change-linked wildfires, worldwide, and demands for more environmental action.

Those events resonated globally, and many of them will still influence the way we work, live, and operate decades from now. This signals durable shifts in stakeholder expectations, and a powerful macro trend.

ESG is about reputational risk

The core belief that sustainability should be central to the future of investing has already led an increasing number of institutional investors to propose investment strategies that pursue strong ESG mandates. This includes using voting actions to hold companies accountable on their progress in integrating ESG elements, such as climate risk, into business models and disclosures.

As banks respond to the growing appetite for ethical and sustainable investments, with ESG products tailored to both retail and institutional customers, the really important question is: If ESG preferences are driven by shifting values and expectations around sustainability and governance, what happens when those customers and investors start challenging a bank’s purported ESG practices—and strongly advocate for new ones?

This is when ESG devolves into a matter of reputational risk.

ESG requires fundamental change

Reputational risk happens when stakeholder expectations evolve, but a company’s core practices remain the same. Once-acceptable ways of operating are no longer considered satisfactory, and companies that adhere to old standards can quickly lose consumer and investor trust.

When driven by powerful external trends, gaps between expectations and reality invariably lead to a strategic inflection point: where business-as-usual can no longer continue, and fundamental changes become mandatory for corporate evolution. Intel’s Andy Grove, who coined the term, saw strategic inflection points as “an opportunity to rise to new heights. But it may just as likely signal the beginning of the end.”

Conventional crisis management tools won’t be the answer. This is about adapting to a new world in which financial decisions are made using three dimensions: risk, reward, ESG impact.

Experimenting early and with intent

For the unprepared, strategic inflection points can feel sudden. In reality, they tend to build up slowly, much like the external trends that drive them. The challenge for senior banking executives is not to fall prey to blind spots, and to proactively—rather than reactively—respond to such changes. They’re inevitable.

A powerful defense mechanism is the eager adoption of external trends. If you fight them, you’re fighting the future. Embrace them and you have a tailwind. Ask yourselves: What are our customers’ latent needs? Where are stones left unturned? Planting seeds that will grow into meaningful new value propositions takes frequent experimentation.

Open-ended questions also help to identify new innovation opportunities:

• What if changes in our ESG score had a material impact on our stock price?
• What if our internal budget allocations were primarily based on carbon impact?
• What if we became net providers of ESG data?
• What if banks could help corporate clients manage their own ESG challenges?

Here is an example. Banks and their corporate clients want benchmarking of ESG efforts against peers, in order to identify areas of improvement and detect potential sources of sustainability riskHowever, accurately capturing data, such as carbon emissions, remains a challenge—particularly for smaller and medium-sized enterprises (“SME”) just getting started on their sustainability journeys. Banks could employ data analytics and machine learning to help SMEs calculate their carbon footprints seamlessly, using activity data in their bank accounts for instance.

Embracing the cloud as a vehicle for innovation

Making sustainability a strategic priority goes beyond adopting greener technologies. While it’s true, logistically, that moving on-premises workloads to the AWS Cloud can help companies reduce the carbon footprint of their IT operations by as much as 88%, this view is too narrow and missing an important point.

Embracing ESG challenges and opportunities is about leveraging the most innovative technologies to develop solutions that will accelerate audacious ESG roadmaps. It is about anchoring a data-centric game plan with digital transformation, and prepare your organization for the growing demand for new types of increasingly granular data and insights—starting with data capture and analytics. It is also about leveraging the cloud’s pay-as-you-go approach to experiment cheaply and with agility to preemptively address rapidly evolving customer and investor needs.

ESG goes beyond a regulatory challenge: It is an innovation challenge. The banks that embrace digital transformation will be best positioned to make early exploratory investments that will become tomorrow’s vehicles for growth.

For more information about AWS solutions, or how to work with the AWS Digital Innovation team in support of your firm’s innovation and sustainability goals, contact your AWS Account Manager or visit AWS for Financial Services.