Dutch financial sector also faces environmental and social risks

A previous DNB study of climate-related risks shows, for example, that a higher incidence of extreme weather events can drive up insurance claims, and that lenders must respond to the implications of stricter regulations, such as mandatory energy efficiency requirements for office buildings and other properties. In the present study DNB, in tandem with several research agencies, looked into other environmental and social risks to which financial institutions might be exposed. Likewise, we explored how 25 large and medium-sized Dutch financial institutions integrate their sustainability ambitions into their operational management.

Risks related to water stress for financial institutions

First of all, we looked into reduced availability of fresh water around the world, commonly referred to as water stress. Rising population levels and economic growth will cause a large part of the world and its inhabitants to face water stress. As it turns out, Dutch financial institutions have invested at least EUR 97 billion in businesses operating in extremely water-scarce regions. If scarcity turns into shortages, business facilities’ operations could risk being blocked or restricted. Likewise, governments could regulate water use more strictly. As a result, financial institutions’ outstanding loans or investments could be exposed to increased risk.

Risks relating to raw material scarcity for financial institutions

In addition, Dutch financial institutions have invested around EUR 56 billion in businesses that depend on the most critical raw materials. Consumption growth and the use of technology are set to boost demand for these raw materials. Many of the raw materials we studied are vital in technological applications. Scarcity or geopolitical factors could increase their supply risks, however, which, in turn, could affect financial institutions that invest in businesses which depend on such raw materials.

Risks related to human rights controversies for financial institutions

Our study shows that human rights controversies arise regularly with respect to businesses in which Dutch financial institutions invest. Various guidelines have been drawn up over the past few years which aim to counter human rights malpractices, such as national covenants on international corporate social responsibility, which the pension, insurance and banking sectors have concluded with the government and civil society organisations. Human rights violations must also be taken into consideration from a risk management perspective, however. Media reports on human rights controversies can expose financial institutions to reputational risk. For these and other reasons, the study stresses the importance of these guidelines.

Risks related to biodiversity loss for financial institutions

Biodiversity is declining rapidly and this, too, could affect financial institutions. Reduced pollination and declining resilience of ecosystems expose investments and lending in the agricultural sector to growing risks. Although scientific studies increasingly reveal these and other ramifications of biodiversity loss, its exact impact on the solidity of financial institutions is still difficult to pinpoint.

It is important for financial institutions to understand the impact of environmental and social risks on their short-term and long-term solidity. For this reason, environmental and social risks must be analysed more closely and managed where needed. This does not imply that risk exposure must be avoided at all cost, as investments that result in risk exposure may be needed to attain environmental or social goals. The instruments available to ensure the risks can be adequately managed must be developed further, however.

Integrating sustainability ambitions into the operational management of financial institutions

According to the present study, all financial institutions we surveyed formulate sustainability policies, and a majority commit themselves to standards like the Sustainable Development Goals or the principles of the United Nations Global Compact. They also issue sustainability reports on a regular basis.

A minority of the 25 Dutch financial institutions we surveyed integrate sustainability ambitions into their operational management. A mere 36% of the surveyed institutions have set concrete indicators and targets as part of their sustainability policies, while only one out of five evaluate the impact of their efforts. Our findings emerged from a study among the Netherlands’ largest pension funds, insurance firms and banks.

Financial institutions expose themselves to reputation risk if they fail to live up to expectations or to deliver on their promises. This means it is important that they set up their operational management so as to provide adequate safeguards. For many financial institutions, logical next steps will be setting clear indicators and targets, monitoring performance and measuring impact.