The Ripple Effect: How Good Governance Builds Outward in Commercial Banking

Originally published on TriplePundit 

The introduction of environmental, social and governance (ESG) issues into financial reporting is slowly but surely bringing clarity to the often complex realm of banking. Driven by calls for transparency from governments and investors, as well as the transition to a low-carbon economy, banks are under pressure to evaluate ESG metrics in their investment and lending portfolios. For example, financial institutions are expected to reach net-zero emissions in their portfolios by 2050, among other ESG considerations shaping the sector.

Banks must establish new strategies and assessments, as well as internal governance and accountability structures, to meet and manage these emerging expectations and requirements. Commercial banking is unique in that it faces more governance stressors compared to other industries. Banks are under strict regulatory oversight, have a wide range of exposure to enterprise risks and are highly sensitive to market volatility. On top of that, they’re expected to lead a financial transformation by effectively managing their ESG risks and impacts: For example, if banks only lend to companies that meet a certain ESG threshold, it forces prospective borrowers to meet those requirements.

Governance in the commercial banking industry is complex — if not overwhelming. To shed some light on the topic, we can turn to the example of one bank that has been able to successfully manage its ESG obligations and emerge as a leader.

Fifth Third Bank’s ESG leadership

Headquartered in Ohio, Fifth Third Bank is one of the largest banks in the Midwestern U.S., with more than 1,100 branches across 11 states. The company’s commitment to sustainability has earned it high marks on ESG ratings systems like CDP and Sustainalytics, as well as building trust and confidence among its stakeholders.

“These actions that we’ve done are not because of the more recent ESG fad. It’s part of our purpose-driven company,” Mike Faillo, senior vice president and chief sustainability officer at Fifth Third Bank, told TriplePundit. “Focusing on sustainability has been part of our business for a lot longer, and that has put us in a position of leadership.”

While the ESG movement may be a relatively new development, the idea of social responsibility in banking has a long history. In 1977, the Community Reinvestment Act (CRA) required banks to service the credit needs of all segments of their communities, particularly those of low-income neighborhoods. In the following decades, corporate social responsibility (CSR) initiatives gained traction and prompted banks and other companies to consider the social impacts of their actions. Fast forward to the current day and we have the ESG movement, complete with ESG investment products, ESG bonds, and ESG rating scales widely available to consumers and investors.

With the complexities involved, many bank leaders know they should be setting ESG targets, measuring their progress, reporting their metrics, and publicly disclosing their findings. But exactly how to do that remains the big question.

How good governance drives ESG strategy

“We believe in transparency, credibility and telling our story,” Faillo told TriplePundit. “Transparency is what breeds trust. To make commitments and then report on those commitments, whether you’re achieving them or not, is what builds the trust.”

The key to achieving sustainability goals and mitigating ESG risks in banking lies in a strong and committed leadership structure. “We used to joke back when ESG was first coined that GSE was already taken so they went with ESG, because governance would’ve been the most important,” Faillo said.

Engagement with stakeholders, both external and internal, to identify priorities and challenges is one of the key first steps in developing a strong ESG strategy. Fifth Third conducts stakeholder materiality assessments to determine which sustainability topics are top of mind. The engagement groups include shareholders, customers, employees, communities and regulators. The methods of engagement are extensive, but include shareholder meetings, focus groups, engagement surveys, business resource groups, and community needs surveys and assessments.

As a result of these stakeholder engagement efforts, Fifth Third’s sustainability committee identified — and the board of directors approved — five corporate sustainability priorities for the company: addressing climate change, promoting inclusion and diversity, delivering on its commitment to employees, keeping the customer at the center, and strengthening the communities where the company does business. Each priority has related metrics and goals that can be measured and tracked to gauge performance.

The priorities, goals, and progress are then communicated to the public to show transparency, provide accountability and build trust. The bank also includes sustainability performance on those identified priorities as a modifier to its employee variable compensation plan — which affects a wide group of employees, not just the bank’s executives. More details on Fifth Third’s sustainability strategy and accountability mechanisms can be found in its most recent ESG report.

The commitment to those sustainability priorities is also evident by the company’s sustainability business resource group, which is open to all employees across the business. “The group is focused on driving employee development and education on sustainability topics,” Faillo said. "We bring in speakers, both externally and internally, to teach and discuss these topics. It also focuses on community involvement and business innovation.” The group has over 750 members and drives many of the company’s ideas about how to overcome hurdles and improve ESG priority performance.

Along with the contribution from employees on ESG topics, the bank’s executives also chair a sustainability committee that meets on a quarterly basis to review metrics and provide another layer of internal accountability. The committee is chaired by the chief corporate responsibility officer, and includes the bank president and CEO, among other high-level executives.

The commitment from Fifth Third to integrate sustainability into day-to-day operations, and not just as something to be done once a year on the side, allows the bank and its employees to be recognized as sustainability leaders in their industry.

What’s next for ESG in commercial banking?

The landscape of ESG reporting is constantly changing, and sustainability leaders need to keep updated on the latest developments. In the U.S., mandatory climate disclosure rules from the Securities and Exchange Commission (SEC) are expected to take effect in 2024, with reporting required for large companies. Similar disclosure regulations are already on the books in the European Union and the U.K., and mandatory disclosures are coming soon to Canada, New Zealand, Switzerland and other countries.

Most disclosure requirements for financial institutions are based on the Task Force on Climate-Related Financial Disclosures (TCFD) framework. A global standard for reporting is also in the works from the International Sustainability Standards Board (ISSB) and is expected to be adopted by more than 40 countries as their mandatory disclosure requirement.

Banks require strong governance structures to prepare for those reporting obligations and develop comprehensive ESG strategies that are integrated into the business. Fifth Third’s work represents a promising blueprint for others in the sector.

This article series is sponsored by Workiva and produced by the TriplePundit editorial team.