Environmental, social, and governance factors are increasingly playing an influential role in the underwriting processes of global banks, according to a new report released Tuesday by Fitch Ratings.

Fitch received responses to its survey questionnaire from 182 banking groups, based in 49 countries. In addition, a smaller number of direct telephone interviews took place with predominantly larger banking groups.

About half of the lending assets covered by the 182 banks that participated in Fitch’s ESG survey in the third quarter of 2019 had been screened by the banks for ESG risks. “Rating impacts on corporates due to ESG-related bank funding decisions are still rare but some sectors, such as those affected by emissions regulations and the rising cost of carbon, may find it harder to obtain bank financing in the longer term,” Fitch said.

For companies committed to mitigating their climate change risk while managing the transition to a low-carbon, more sustainable economy, “transition financing” is likely to become a vital route to obtain bank financing. Fitch also expects borrowers with higher ESG risk will continue to be supported by local and state-controlled banks, particularly for high-profile national projects, or find substitute financing from banks with fewer ESG constraints. Alternatively, some higher ESG risk borrowers may obtain funding via the capital markets.

Banks that participated in the survey jointly cited their company policies and regulation as the most important drivers for incorporating ESG into their underwriting processes. “This reflects in part the view that banks are increasingly taking the issue seriously and that pressure from potential regulatory changes is increasing,” Fitch said in the report. Reputation and litigation risks also appeared to be important factors, with several banks citing stakeholder or investor pressure as their main driver to screen for ESG risk.

Banks’ monitoring of ESG risk generally results in greater due diligence rather than outright deal rejection. According to the survey findings, the extractive metals and mining sector was most likely to be scrutinized by banks for environmental risks, followed by chemicals and fertilizers. The gaming and leisure sector was singled out for social risks—for example, addiction, crime, and money laundering—which can lead to reputational risks.

Regional differences

According to Fitch, the main “no-go” area banks flagged was transactions carrying a high risk of human rights violations. Many banks, particularly those in western Europe, also prohibit new project financing for thermal coal mining and coal-fired power stations. The survey also found banks within eight European countries—Belgium, Ireland, Italy, Liechtenstein, Luxembourg, the Netherlands, Spain, and Switzerland—appear most likely to avoid financing or investing in armament manufacturers.

The survey also found ESG emphasis varies by bank size and region. Large- and medium-sized banks, with consolidated assets of more than $100 billion, were much more likely than their smaller peers to apply ESG policies to financing decisions.

African, Latin American, and western European banking groups were generally more likely to apply ESG policies to their financing and underwriting than North American and Asia-Pacific groups. “The findings support the view that banks with investor bases that are sensitive to environmental or sustainability issues, and those more susceptible to stakeholder pressure, will tend to have a more sophisticated ESG screening policy,” Fitch said. “Banks with global trade and underwriting operations also tend to have greater exposure to ESG risks and so are more likely to develop detailed underwriting policies and restrictions.”