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Financial Performance and Sustainability Assessments of Financial Institutions

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Financial Performance and Sustainability Assessments
of Financial Institutions

Layal Khalaf

Supervised by:

Prof. Haitham Nobanee

Abstract

Sustainability has become an important concept nowadays as most activities in different sectors

have incorporated this concept by utilizing green technology and other clean technologies.

Ignoring this concept can result in drawbacks in the long term especially, in meeting the needs of

future generations. Several different topics fall under sustainability and neglecting its importance

can put economies in critical situations. The financial sector is exposed to these risks as funding

projects that result in environmental damage and climate changes can put everyone at risk by

increasing death rates and health issues. There is an argument of how sustainability is connected

to the financial performance in banks and several other firms. Hence, this research will cover the

importance of corporate responsibility and its incorporation in banks, the connection between

bankruptcy and sustainability, the challenges of sustainable development and how the banking

sector faced it, and several climate risks and its effect on the banking sector. This will help in

exploring the different initiatives taken by banks and other firms regarding sustainability.

Keywords: Sustainability, financial sector, financial performance, bankruptcy, banks,

corporate responsibility, clean technologies.

 1. Introduction

Taken from China, one of the world strongest economies, it has been shown how drawbacks can

occur in an economy that does not consider the negative consequences of the environment on its

economical operations (Weber, 2017). According to a document posted by the International

Finance Corporation World bank group (n.d.), pollution and climate change can put institution into

several risks. Firstly, there is the liability risk which includes putting penalties and fines of the

environmental factor is neglected. The financial risk that the institution can be exposed to is when

a disruption happens in an operation between the client and the other side (financial institution).

For example, a site must be cleaned using the internal sources before it can be sold. Also, the

reputational risk can be harmed due to the negative public comments that can be directed on

institutions if they do not value the community and respect the social practices. This can affect

their image and brand between their investors and clients. Finally, there is the market risk which

can affect the transaction of a contaminated site. It is important to recognize how sustainability is

an important factor in managing institutions and avoiding their drawbacks. Programs have been

done in different banks around the world involving sustainability and the effects of climate change

on these banks. It has become a duty for leading banks to incorporate climate change as an issue

that can affect the operations of banks. Hence, it is important to disclose all information in

regarding these issues to be able to set sustainable financial goals. In this paper, the focus will be

on corporate sustainability and its impact on performance. Moreover, several risks and assessments

about the linkage of sustainable issues with the firm’s financial performance and decisions will

be evaluated in regards to the cost of capital, profitability, and investments (Al Ahbabi & Nobanee,
2019). Then the examination of how climate changes affect banks is vital as policies have been

imposed by several different countries to understand how banks incorporated these changes with

the financial sustainability program.

2. Literature review:

Corporate Sustainability

As stated, China has been one of the economies that is experiencing rapid economic growth, but

with drawbacks due to the unpleasant environmental impact formed. For this, it has implemented

a new green credit policy which is recognized and appreciated internationally. This policy involves

the integration of their financial decisions with the environmental problems faced. All this is

imposed to encourage banks to adapt to the concept of achieving the green economy which means

combining green innovation within its financial sectors. In China, they mostly started and focused

on banks. A main function of this program, which has been gone over by three different agencies,

is to impose restrictions on industries that are involved in pollution as well as fixing an interest

rate that is dependent on their performance environmentally. Moreover, facilities that are involved

in for protection of the environment and infrastructure would have to approve of the reduction of

the interest rates in the loans. Also, it has shown that the industries involved in pollution have

higher interest rates imposed on them than the non- polluting industries. It has been stated that

their economy is going towards a more green and sustainable economy. This topic is debatable

since it is not known whether this will impact the performance positively. However, findings have

assured that the correlation between sustainability and financial performance is positive. The

theoretical background behind it has shown that sustainability would result in a reduction in the

costs and improves their reputation. At the same time, if the financial performance is improved
then this will influence their “corporate sustainability” since it will provide access to other

financial resources that is needed for integrating sustainability into their operations (Weber, 2017).

Connection between bankruptcy and sustainable growth

Corporate bankruptcy is related to a legal procedure in which a company would be insolvent

making it uncapable to pay its obligations. Studies have assured that the assessment of liquidity

ratios, profitability, and other solvency ratios is needed to predict bankruptcy and growth

sustainability. Evaluating these rates are vital to achieve sustainable growth and validate the

predictions. Bankruptcy is known to be a concern for multiple organizations, especially the

emerging ones. Hence, analyzing these statements and utilizing these ratios will help organizations

in achieving a clear vision about their conditions and if they will be able to adapt in terms of

financial sustainability (Al Muhairi & Nobanee, 2019).

Sustainability declaration

During the past times providing sustainability reports were not that vital and where not even

required to be filed by banks and corporations; however, due to the drastic increase in the

environmental damages and climate changes. Firms are engaged in different activities that can

trigger environmental damages to the community which has raised the issue of an increase the

health issues and death rates. Hence, establishing sustainable initiatives will help in creating the

social value amongst the stakeholders of the organization. This can be done by creating a value

amongst the employees about the importance of sustainability. Secondly, employing

environmental audits to assess the effects and check whether engagement in sustainability is

positive. Finally, check if the firm complies to the laws and applies them incorporation with the

sustainability laws to portray a positive image (Al Nuaimi & Nobanee, 2019).
Challenges of sustainable development and the response of the banking sector

Few years ago, many political leaders, governments, and UN members have agreed to discuss the

environmental crisis faced by the world and ways in which policies are to be put in order to

diminish the environmental destruction caused. It has been emphasized the importance of the

banks’ role and the entire financial sector in protecting the environment and the creatures living in

it. Nowadays, banks are very important especially in the environmental and sustainable area.

Banks are subjected to criticism due to their investment in industries that are involved and

connected to climate change; for example, mining industries and others that are connected to the

environmental destruction. All this has led to creating and imposing policies and regulations that

act for enhancing the sustainability in the financial sector. Since banks play an important role in

the growth of the economy, economies will expand more if the future needs are sustained and

maintained properly. Some attributions banks did in order to establish and enhance their

contribution in the sustainability sector. Firstly, they created a community to impact more

international companies and encourage governments about the importance of having more

transparent investments. Secondly, in some developing countries people, are simply not linked to

the financial sector due to them not having a bank account. Connecting with these people will

impact positively on this community since they represent a major part in developing countries.

Finally, connecting social finance with traditional finance which is considered a type of “fair trade”

will attribute positively (Stephens & Skinner, 2013).

Climate Risks on Financial sector

Over the past decade, the financial risks related to climate change have started to increase not only

micro levels of the economy, but also the macro levels. The estimated costs economically related

to natural disasters and other weather events have been 140 billion dollars. Moreover, it has been

estimated that by 2085 the claims related to climate will add more burden to the insurance sector

due to expected increase in sea level and other climate events. There are several financial risks that

can be faced in the banking sector due the climate change. The physical risk can be uprisen due to

the unexpected changes in the climate and the transitional risk can be from switching into a “low-

carbon” economy. The physical risks can affect the values of the equity and other instruments by

reducing revenues and sales and increasing the operational risk, capital costs, and costs arising

from the environmental and climate changes. On the other hand, the transitional risk can include

the high prices of carbon, acquiring subsidies for using carbon technologies since we are shifting

to a low-carbon economy. These types of risks appear when operations are adjusted to a more

carbon neutral economy, which on the other hand can cause a decrease in the asset and energy

prices suddenly causing a disruption in the balance sheet of the banks. Climate change has been

modifying these banks; hence, it is important that they should start incorporating the impact of

climate change and risks into their risk management and strategic planning frameworks. This can

be done by evaluating their loan portfolios and their operations for any consequences they may

face from the physical and transitional risks. Banks should enhance the accuracy of their

information regarding the climate risks and provide a sustainable system and begin a system that

detects the climate risks (Feridun & Güngör, 2020).

 3. Results and Discussions

Previous researches have considered that the banking sector is highly exposed to the risks resulting

from the issue of sustainability. One of the main issues is that these banks have been responsible

for the pollution of the environment due to their investments and projects that are connected to this

issue. Hence, the European banks have been obliged to the concept of corporate social

responsibility. This will help in identifying these issues related to sustainability and how they are

interpreting it. Several issues were explored in this sector in order to provide an environment that

is considered to be relatively clean as banks have the ability to influence the behavior of their

clients. One of the instruments that have been used is codes of conduct; however, the most popular

instrument is sustainability reporting that is required by all banks nowadays (Viganò & Nicolai,

2009).

Commercial banks have taken some initiatives in the green investment area. The united nations

have launched a framework that utilizes clean technology investment for the economy. Moreover,

using a more natural infrastructure will stimulate growth and battle any climate change while

increasing the natural employment at the same time. Also, working towards these initiatives

requires banks to take actions such as having members that care about the natural environmental

resources and finding several ways and techniques to lower the costs and maintain strong

relationships with customers that have firm views about the importance of sustainable

development. In order to achieve these initiatives in compliance with the green economy strategy,

banks should create green workplace offices, incur investments in low-carbon development

projects, and provide monetary funds for projects that are connected to the creation of

environmental infrastructure (Ganbat, et al., 2016).

As mentioned, climate change has played an important role in altering the banks performance and

strategies. Several suggestions were made and according to a research banks should opt-out

“factoring” in the carbon market as the regulations for expanding and trading globally has been

reduced. This can put them in an advantageous position and aid in the construction of the

management of carbon emissions while investing in clean energy that is efficient in for using

renewable resources which can help in generating a revenue of 1 billion dollar (Cogan, 2008).

4. Conclusion

To conclude, sustainable development has become an important factor to consider especially in

the financial sector. Well-developed economies have been suffering drawbacks due to the

environmental damage or the extreme climate changes. Banks have the highest exposure and can

develop several risks such as transitional risks and physical risks. In order to become efficient

banks began taking initiatives in order to achieve sustainable development. Some measures

included shifting to a low carbon economy, sustainable reporting, and enhancing the accuracy of

the information provided by banks regarding sustainability. Most European banks have been using

the concept of CSR. As mentioned, climate changes have been a vital reason in putting a banks

performance into a critical situation. Hence, the utilization of green technology and investment in

low carbon development projects can increase efficiency and also generate high amount of revenue.
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