Abstract
Background: Environmental risks, defined as any potentially negative financial impact due to environmental conditions, are considered in several ways within the international banking sector. But, in the South African banking landscape, objective standardisation of environmental risk consideration is lacking due to different expectations by government departments, reputational drivers and the threat of greenwashing.
Aim: This study aims to investigate the perceived future of environmental risk considerations in the banking sector of South Africa.
Setting: This study was carried out within the South African banking sector, using six different banks representing 80% of the market share.
Method: We interviewed representatives from six banks using the Seven Questions Method, then identifying temporal themes and sub-themes framed using Institutional Theory.
Results: The results showed an ongoing evolution in environmental risk considerations. Past considerations were compliance-driven, with the present drivers being increased professionalisation within organisations and the need for industry regulatory alignment. The future will include further standardisation in the industry and benchmarking between organisations, expecting continued regulatory reform and mainstreaming of environmental risk consideration.
Conclusion: According to the participants, the future should address challenges and prevent greenwashing while standardising the approach to environmental risk consideration throughout the South African banking industry. The participants’ reactions highlighted that Institutional Theory remains important, especially mimetic forces and isomorphism, in the current and potential future consideration of environmental risk.
Contribution: This study shares the perception of the South African banking sector regarding environmental risk consideration and identifies the drivers that resulted in the current state, as well as those shaping the future.
Keywords: environmental risk; banking sector; South Africa; future; finance; environment.
Introduction
Environmental risk is becoming an increasingly important consideration within the banking sector (Breitenstein, Nguyen & Walther 2021; Salama, Anderson & Toms 2011), understood as any environmental conditions, ecological change or changes in environmental policy that may result in adverse financial consequences (losses) for banks, directly or indirectly through their operations (Breitenstein et al. 2021; Network for Greening the Financial System [NGFS] 2019; Salama et al. 2011; Verheyden, Eccles & Feiner 2016). This includes social responsibility as taken within the environmental, social and governance (ESG) framework (Breitenstein et al. 2021). Environmental risk poses a potential financial risk to banking institutions (Muhammed et al. 2015; Verheyden et al. 2016) classified into three categories. Firstly, direct risks, which are the risks arising from the bank’s own operations (Thompson 1998); secondly, indirect risks, where banks are exposed to environmental risk through their role as intermediaries (Batten, Sowerbutts & Tanaka 2016); and thirdly, reputational risks, where the bank is at risk because of market perception (Case 1996; Thompson 1998).
However, although physical environmental change can influence the environmental risk the banks are exposed to, the transition of the economy in response to environmental risk also imposes risks on the banking institutions (National Treasury 2021). Currently, international protocols and frameworks are in place to drive the incorporation of environmental risk into the financial sector, thus creating the expectation for environmental risk inclusion. However, the exploration and understanding of environmental risk inclusion, especially from the perspective of banking employees familiar with the internal operational framework in the South African banking sector, has not been done. This includes their perception of the future of environmental risk inclusion in their daily operations.
The origin of environmental risk consideration within the banking system can be viewed as a corporate behavioural result based in Institutional Theory, especially since this risk consideration was, at least partially, motivated by social, legal and regulatory environmental changes, rather than purely economically motivated (Kılıç et al. 2021; Tolbert & Zucker 1996). According to Kılıç et al. (2021), banks, like most other organisations, incorporate generally accepted practices because of the institutional pressures applied, possibly by the wider industry, whether it be proactive or reactive to requirements, essential for the organisation’s long-term existence. Institutional Theory is also useful as an approach to our study, as it acts through three different forces to drive change within an organisation (Kılıç et al. 2021; Osinubi 2020). These are, firstly, coercive force, which consists of the regulatory drivers that influence an organisation (Alon & Dwyer 2016; Kılıç et al. 2021; Osinubi 2020). Secondly, the normative force that drives organisations to incorporate what is widely considered correct and logical to incorporate, which, in the case of banking organisations, relates to the protocols and agreements that guide their disclosures and investment considerations (Alon & Dwyer 2016; Osinubi 2020). Thirdly, the cognitive or mimetic force that describes the tendency of organisations to, especially during uncertain times or about uncertain topics, model their reaction or approach based on those of other organisations (DiMaggio & Powell 1983; Kılıç et al. 2021; Martínez-Ferrero & García-Sánchez 2017). This is especially prominent, as expected, between organisations that are under similar pressures, whether it be complying with standards of reporting or direct environmental pressures (Kannenberg & Schreck 2019). Therefore, Institutional Theory provides a useful method to interpret findings of studies where changes and perceptions can transcend independent organisations, resulting in potentially shared approaches (Lammers & Barbour 2006; Lammers et al. 2014).
Environmental risk consideration in the banking sector remains an evolving topic; thus, the problem we investigated in this article is to determine the perception of insiders in the banking industry with regard to environmental risk. This study aims to examine the perceived future of environmental risk considerations in the South African banking sector. The first objective is to determine the perspective of professionals within the South African banking industry on how environmental risk is considered. This is achieved by gaining insight from interviews with professionals in the South African banking sector using a Futures Thinking approach, allowing the evaluation of participant responses under the past, present and future themes. The second objective for this article is to develop a framework that describes the evolution of environmental risk consideration in the South African banking sector from an insider perspective, identifying potential future drivers that will shape the approach to environmental risk consideration, as defined here.
Literature review
The literature review describes the evolving understanding of environmental risk within the banking sector as a basis for the Futures Thinking methodological approach. Moreover, Institutional Theory is used as a theoretical framing.
Environmental risk in the banking sector
Banks are generally exposed to environmental risk through their role as financiers (Ahmed, Ahmed & Hasan 2018; Bimha 2020). This came from the original lender-liability concept that allowed banks to be held responsible for environmental remediation or restoration of properties that the original borrower defaulted on (Al-Tawil 2017). However, this evolved into three different environmental risk categories that can have financial implications for banks, including physical risk such as floods (Bimha 2020; National Treasury 2021), transitional risk resulting from trends in the industry that develop away from financed infrastructure (National Treasury 2021), and liability risks arising from inappropriate disclosure of environmental risk (Dikau & Volz 2021; National Treasury 2021). The development in understanding of these risks and their international impact resulted in protocols established and used to define and drive incorporation of environmental risk consideration in financial institutions, primarily through disclosure standards, such as those established through the Equator Principles (Bimha 2020; Equator Principles Association 2022), the United Nations Principles for Responsible Banking (United Nations Environment Programme – Finance Initiative [UNEP_FI] 2022), the United Nations Sustainable Development Goals, the Paris Agreement (Department of Forestry, Fisheries and Environment [DFFE] 2017) and the Task Force on Climate-related Financial Disclosures (TCFD 2017). The TCFD attempted to standardise reporting and was replaced by the International Financial Reporting Standards (IFRS) S2 in 2023 (IFRS 2024). The TCFD was made up of 32 members from various nations and represented a variety of financial institutions, with the goal of developing recommendations that can be widely adopted and incorporate environmental risk into the financial sector (TCFD 2017), and its goal is continued by the IFRS to improve transparency and accountability in financial sector reporting globally (IFRS 2012).
The current consideration of environmental risk in the South African banking sector is largely dependent on international frameworks, as mentioned previously, industry-led principles and legal liability. South Africa’s legal framework establishes this basis for environmental risk within the Constitution (Section 24), stating that the environment should be protected for current and future generations (RSA 1996). The national governance of the environment is conducted through the National Environmental Management Act 107 of 1998 (NEMA), which establishes principles for environmental decision-making and cooperative governance, laying the foundation for individuals and companies to be included in environmental management (RSA 1998). The National Environmental Management Act directly relates to banking by imposing environmental compliance risks on their operations. In addition, the King IV Report on Corporate Governance outlines environmental governance requirements for companies (Bruner 2022). Although adherence to the King IV Report is voluntary, several South African banks use it as a benchmark (Absa 2022; Nedbank 2021; Standard Bank 2018). Banks listed on the Johannesburg Stock Exchange (JSE) must also comply with sustainability disclosure requirements that include considerations of climate change, water security, biodiversity and land use, pollution and waste, and supply chain impacts (JSE 2022). In South Africa, environmental risk consideration is thus included in banking protocols, but formal regulatory prescriptions for integrating environmental parameters into financial risk decisions are lacking (Bimha 2020). Currently, some formalisation is emerging that would include environmental risk, but making environmental risk consideration a mandatory or regulatory requirement is considered necessary to lead to a standardised approach (Banking Association of South Africa [BASA] 2015; National Treasury 2021). This shift would inevitably lead to new business models that banks would need to incorporate.
The future of environmental risk consideration within any financial sector entity is based on their risk management, metrics and goals (TCFD, 2017). This is realised, as mentioned, with the lender-liability concept (Al-Tawil 2017) and the need for financiers to be cognisant of the environmental risk associated with loans. Moody’s estimated that loans in sectors with high or very high environmental risk amounted to $4 trillion worldwide in 2023 (Moody’s Ratings 2023). Although the lender-liability concept and the recommended disclosures by the TCFD exponentially increase the environmental risk banks are exposed to, this also empowers banks in environmental risk mitigation (Wu & Shen 2013), but the exploitation thereof has been limited to date. A global study on banks reported that only 27 out of 135 (or 20%) incorporated environmental risk management into their financial regulations (Dikau & Volz 2021), despite the Intergovernmental Panel on Climate Change (IPCC) warning that the threat and impact of climate change for economies require immediate policy action (IPCC 2018). The low incorporation of environmental risk seen in 2021 can be the consequence of not all countries requiring environmental risk consideration through legislation, but international protocols agreed to and the TCFD recommendations place that expectation on financial institutions. This is the case in South Africa, with it being a signatory to the United Nations Principles for Responsible Banking (UNEP_FI 2022), the Equator Principles (Equator Principles Association 2022), and, through the DFFE, to the Paris Agreement (DFFE 2017). This underscores the fact that banks have significant socioeconomic impacts through the financing they provide, through employment and economic growth (Beck, Demirgüç-Kunt & Levine 2010).
Institutional Theory
Institutional Theory best describes the consideration of risks in the banking sector, as both internal and external forces drive organisations such as banks to standardise their approach. This is further explained by the behaviour of an institution ultimately being the result of the institutional environment in which it operates (Campbell 2007; DiMaggio & Powell 1983; Kılıç et al. 2021). This results in different organisations adopting similar generally acceptable approaches, because of the example set by the larger industry (Aerts, Cormier & Magnan 2006). Institutional Theory consequently describes that the approaches or behaviours of organisations are ultimately influenced by social, legal and political factors, apart from the economic considerations taken, especially for companies operating in similar contexts (Purdy, Alexander & Neill 2010), which also influences the credibility of the organisations considered (Simnett, Vanstraelen & Chua 2009). When considering banking institutions, the need is often to balance national needs and expectations with those of internationally established standards, such as those stipulated by the IFRS (Alon & Dwyer 2016; IFRS 2024; Purdy et al. 2010).
Institutional Theory itself explains inter-organisation standardisation through three primary mechanisms, as mentioned in the introduction. The coercive mechanism, which drives different organisations to have similar behaviours, arises from the regulatory framework within which these organisations operate (Osinubi 2020). This is dependent on the legislation of the different countries, such as those requiring specific disclosures and reporting, with potential verification requirements (Alon & Dwyer 2016; Purdy et al. 2010; Simnett et al. 2009). However, this coercive (also known as regulatory) force also overlaps with the second mechanism incorporated in Institutional Theory, the normative forces. These normative forces often represent standards that are adopted by organisations, thus allowing different independent organisations to independently adopt the same standards, and are often considered crucial for the credibility of the organisation (Martínez-Ferrero & García-Sánchez 2017). In the banking sector, this is exemplified by the IFRS and its adoption by regulatory bodies such as the Securities and Exchange Commission (SEC) of the United States (Alon & Dwyer 2016). This regulatory and normative forces overlap is not always the case and is highly dependent on regulatory allowances but often lends credibility to organisations from a public perspective and thus often drives banking organisations to greater transparency and accountability, both to the general public and regulatory oversight (Campbell 2007; Kılıç et al. 2021; Osinubi 2020). The last driving force in Institutional Theory also results in different organisations adopting the same behaviours, but in this instance, it is through the direct copying of actions and reactions of successful organisations by others in the industry, termed the mimetic force (Kılıç et al. 2021; Osinubi 2020; Trevino, Thomas & Cullen 2008). The ultimate result is the adoption of similar approaches within an industry, and within banking, this is exemplified by the incorporation of integrated reporting (Kannenberg & Schreck 2019). Often, when different organisations adopt similar approaches and behaviour, it is driven by legitimacy enhancements and management of reputational risk (Kannenberg & Schreck 2019; Lammers & Barbour 2006; Osinubi 2020). Ultimately, although Institutional Theory can be described by these three different forces, the way in which organisations develop often involves more than one of these forces acting concurrently (Trevino et al. 2008).
Methods
This study uses a Futures Thinking methodology based on the Seven Questions Method described in the following sections (Government Office for Science 2017).
Research design
This study conducted semi-structured interviews with a range of South African banking industry insiders to gain perspectives on the evolution of environmental risk consideration within the banking industry (Government Office for Science 2017). This is a qualitative, explorative research design applying an interpretive framework to analyse interviews (Merriam & Grenier 2019). The research also employed an inductive investigative approach to allow new information to come from interviews and not be limited to predefined hypotheses, with the researchers themselves acting as the primary instrument for both data collection and data analysis (Delve & Limpaecher 2023).
Interview sampling
Purposive and snowball sampling from initial participants was applied, with a specific focus on gaining the perspective of senior banking representatives who have suitable knowledge and experience with environmental risk consideration in the South African banking sector. Although no specific total number of interviews was set, the objective was to select interviewees who represent financial institutions that cover at least 80% of the market share in South Africa. The final cohort comprised 13 interviewees from six banks. Table 1 shows the coding used to ensure the anonymity of participant organisations and individuals.
| TABLE 1: Position and anonymous codes of participants. |
Recruitment
Although participants were recruited based on their seniority, allowing them to have dealt with and have experience with environmental risk in the financial sector, a similar level of familiarity with the concept was not a prerequisite, which allowed for a variety of perspectives. Individuals from six prominent banks in South Africa, selected based on their 80%+ market share, were chosen because they were representatives of their respective institutions for environmental risk and green banking initiatives at the BASA. Further participants were identified through LinkedIn searches for roles related to environmental risk, employing search terms such as ‘Environmental Risk’, ‘ESG Risk’ and ‘Sustainability’. Finally, some participants were also selected through facilitated introductions by other participants, concluding the snowball sampling. The anonymisation is described in the ethical considerations section.
Data collection
Data collection was done through semi-structured interviews conducted during virtual meetings, using the provided recording and transcription functionalities of the software. The interviews were guided by predetermined questions from the Seven Questions Method that were adapted to elicit open-ended, but guided, responses from the participants (Bryman et al. 2014). All interviews started by presenting the participants with the context of the study and an overview of the origin of environmental risk in the financial sector, as well as being informed of the interview structure. The questions were then presented electronically during the interview to assist the participants (Table 2). The first question highlights the critical issue that might affect the topic being studied and sets the context for the rest of the discussion, while the second and third questions consider the possible positive and negative outcomes within the context. The fourth question deals with the critical considerations needed to ensure a positive outcome, while the fifth is oriented towards identifying what conditions led to the present situation. The sixth question highlights what the participant may consider crucial actions to be taken to ensure a positive outcome. The last question allows participants to express their desired vision without restrictions, acting with complete authority.
Data analysis
All interview recordings were transcribed, and errors were corrected after review. Upon analysis, key themes were identified based on the words or phrases, as well as the specific topics, models, frameworks, processes or applied principles referred to by the participants. This allowed the determination of the importance of different themes based on the mention of these themes across multiple questions. Responses were studied as trends within different institutions; thus, any differences are attributable to differences between the different banks or the diversity in participants’ backgrounds. The findings were further analysed within the interpretive framework, inductive in nature and situated within the literature reviewed.
Ethical considerations
Ethical clearance for this study was obtained from the North-West University, Faculty of Natural and Agricultural Sciences Research Ethics Committee (FNASREC) with approval number (No. NWU-01215-22-A9). Written interview consent was also obtained from interviewees prior to the interviews. Consent included permission to record the interviews, while all institutions and participants were anonymised.
Results
Environmental risk consideration in South Africa has evolved according to our participants. Figure 1 reflects the mechanisms seen to drive the evolution according to our identified themes of past, present and future, together with the sub-themes as identified from participant responses. What is specifically reflected in the figure is that the context for environmental risk consideration was initially set by regulation, but this has since evolved to our current situation where increased incentive for professionalisation of the discipline of environmental risk within the organisational structure is defining the context. The present is also characterised by a drive to align different regulatory requirements, although this was identified as not being fully accomplished. The perceived future is, however, driven by standardisation of practices between organisations in anticipation of regulatory alignment, leading to convergence of environmental risk consideration within the industry. This is also further driven by the organisations through adaptation of priorities, where environmental risk evaluation is seen as equally important as financial indicators. The sub-themes will be discussed in further detail below. The questions and associated responses were organised to illustrate the responses of the interviewees with respect to the past, present and future of environmental risk consideration within the banking sector.
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FIGURE 1: Perceived evolution of environmental risk consideration in the South African banking sector. |
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The past (Question 5)
The development and incorporation of environmental risk into banking began when adverse environmental influences disrupted entire value chains and affected the financial performance of banks (Bright & Buhmann 2021; Felbermayr et al. 2022; Tol 2018). Although this may have created the necessity to consider environmental risk, participants also highlighted several other sub-themes.
Regulatory compliance and adoption of external frameworks
The inclusion of environmental risk into banking, participants argued, was instigated by the perceived and real risks to the business operation of the bank itself, realised after losses occurred as a result of client non-compliance with environmental regulations. According to the participants, the initial drive to include environmental risk came from the environmental regulations placed upon the clients of banks, such as the NEMA and the Sector Environmental Management Acts. Different protocols have also emerged to increase transparency of environmental risks in all companies, not just banks. Institutions and non-profit organisations began to develop IFRS for larger companies and financial institutions alike (Bimha 2020; Kannenberg & Schreck 2019) to increase transparency with regard to environmental impact. These protocols are, for example, the Equator Principles, 4th iteration (Equator Principles Association 2022), the JSE standards (JSE 2022) and the TCFD. The replacement of the TCFD by IFRS S2 in 2023 brought new standards complying with both the previous TCFD standards and the International Sustainability Standards Board (ISSB) standards (IFRS 2024). Together with the adoption of external disclosure standards, activist activities (JustShare) that track and report on banks and their environmental commitments and the proactive adoption of sustainability principles were also highlighted as additional factors leading to environmental risk considerations in the banking sector.
This past view of environmental risk inclusion as described by our participants is characteristic of coercive isomorphism (DiMaggio & Powell 1983). This results from different organisations adopting similar behaviour as a result of the regulatory oversight placed upon them by a more authoritative entity, i.e. national governments (Aerts et al. 2006). This drive to conform to regulation also forms part of the regulative pillar of Institutional Theory (Osinubi 2020; Trevino et al. 2008), which can be a powerful tool to standardise an industry in a top-down approach, laying the foundation for how environmental risk is considered within the banking industry today.
Institutionalisation of environmental risk considerations
The development of these inclusions and the increase in complexity resulted in the adoption of formal Enterprise Environmental Management Frameworks (EEMFs), Environmental Management Systems (EMSs), ESGs and other tools to increase the incorporation of environmental risk management in the banking sector. However, participants have indicated their concerns about the constraints of the current consideration of environmental risk when it comes to banks reducing their own environmental impact. The participants noted that although these different sources brought environmental risk into consideration in the banking sector in the past, the continuous development, as well as the in-house application, of these principles remains important.
Institutionalisation of considerations of environmental risk in banking is often also driven by individuals within the organisations and proactive adoption of standards, according to the participants. This institutionalisation is also part of the sedimentation of characteristics, as described in Institutional Theory (Tolbert & Zucker 1996), thus indicating that it has become part of institutional culture and logic (Lammers & Barbour 2006; Lammers et al. 2014; Osinubi 2020).
The present (Question 4 and Question 6)
The participants indicated that currently, inclusion of environmental risk and policies allowing for this are progressing, although improvement is still possible. They indicated that they felt that some internal actions can be taken within the structure of the banks but also that any adaptation or drive in the future will have to be supported from a regulatory viewpoint. The sub-themes that emerged from their interviews are discussed below.
Professionalisation of environmental risk as discipline
Six participants expressed their opinion that board members of banks should be expanded to include environmental and climate risk expertise, whether it is by including additional members or expanding the expertise of current members, similar to Dikau and Volz’s suggestion that all institutions should incorporate environmental risk (Dikau & Volz 2021). In this regard, eight participants also felt that environmental risk management should be formalised into a profession within the standards of the South African National Qualifications Authority and that trained skills should include social, environmental and ecological science, as well as engineering and financial expertise. This added professionalisation would also be compatible with established ESG expertise (Verheyden et al. 2016; Whelan et al. 2021). This establishment of a profession would address the need for standardisation in the evaluation of environmental risk but ensure competent individuals to fill the expected future demand. All participants mentioned the lack of universal standards for environmental risk consideration and thus further necessitated the need for its standardisation, as will also be explored under the following sub-themes.
Potentially formalising environmental risk in the financial sector as a profession and including this expertise on the managing board of institutions can increase the normative isomorphism, as described by Institutional Theory (Aerts et al. 2006). The inclusion of formal education, as posited by Institutional Theory, can also establish a standard theoretical foundation for any future professional in the field and thus guide the behaviour of professionals (Kılıç et al. 2021; Lammers & Barbour 2006). Standardised approaches to environmental risk consideration within banking institutions can legitimise internal management practices, allowing potential dispersion of these methods between institutions through mimetic drivers, which will drive more transparent and comparative reporting standards in the wider industry (Kılıç et al. 2021; Osinubi 2020; Trevino et al. 2008).
Transparency and comparative reporting
Transparent and efficient reporting remains important for any banking institution, which includes the reporting on environmental risk exposures of financed companies. Participants were divided on whether this should only be done after reporting standards have been agreed upon or beforehand. Two participants indicated their intention to publish their institution’s greenhouse gas (GHG) emissions report, with the expectation that other banks would follow because of reputational pressure. This confirms the mimetic forces that are currently acting on the banking industry but also potentially on other industries (Gatzert 2015). Other environmental issues such as biodiversity impact and water use can be more transparent and reportable with improvement in means of measuring, aided by professionalisation. The option to proactively consult with clients on measures to de-risk their industries on present and future environmental risks was also suggested by the participants and can be a valuable contribution to transparency and foresight.
All participants also indicated that improving data availability and quality is necessary to improve the effectiveness of environmental risk assessment. Three participants specifically noted transactions where existing models failed to estimate environmental risk within acceptable uncertainty limits. Increasing the number of environmental risk perspectives, along with the timeframe for projected risks, decreases the ability to assess the environmental risk of a transaction, which would add complexity to any organisation’s operations and limit its effective operation (Aguinis, Ramani & Alabduljader 2018). Participant B2 added that this issue is worsened by the abundance of methods and techniques available to quantify ‘environmental’ risk, more than 200 according to the participant. This results in a cognitive uncertainty that pushes organisations to use similar approaches, mimicking industry leaders seen as successful to legitimise their own approaches (Aerts et al. 2006; Lammers & Barbour 2006). An example of this was given by Participant B3, where smaller subsidiaries of parent companies may perform better on Carbon Disclosure Project (CDP) reporting being based on year-on-year improvement. The smaller subsidiary benefitted from easy improvement, despite having significantly higher negative environmental impacts than the parent company. This created a false perception of sustainability and thus an opportunity for greenwashing, remaining a threat to the reporting of environmental risk.
Alignment with regulation and policy
Some potential actions to improve environmental risk consideration in the banking system identified were outside of the direct control of banking institutions but within their sphere of influence. This includes the dissociation between expectations of different government departments, specifically the currently contradicting requirements of the Department of Mineral Resources and Energy, the DFFE and the National Treasury (DFFE 2017; National Treasury 2021). The potential for regulation to precipitate coercive isomorphism (Aerts et al. 2006) is also exemplified by Participant B4 noting that ‘Regulation moves first’; therefore, it is not only the responsibility of the banking sector to envision this future but also that of national departments and regulators. This is further argued to be necessary, as without the regulatory guidance, the quality of reporting would be impossible to ascertain.
All participants did agree that ‘Regulation moves first’, but it would also be detrimental for one bank to enforce stricter regulations than its competitors beforehand, since it would result in the regulatory arbitrage effect and the dependence on third-party information for verification of compliance with regulations, as well as reputational risk. Participants from five of the six banking institutions did, however, indicate that they have specific programmes to consult with their clients to de-risk them from the impact that international agreements will have on their trade within carbon-intensive economies such as that of South Africa. However, although the participants had the opinion that South Africa would not be able to de-risk its industries according to the Paris Agreement and UNEP_FI (DFFE 2017; UNEP_FI 2022), these commitments guide legislation development that ultimately contributes to the future regulative forces driving environmental risk consideration (Kılıç et al. 2021; Lammers & Barbour 2006).
The perceived future (Questions 1, 2, 3 and 7)
The participants agreed that environmental risk will be increasingly incorporated in all sectors of business in the future, including the banking sector. Traditionally, environmental risk was only considered by industries that could be the biggest offenders, such as mining and energy generation. However, now environmental risk is a consideration throughout the value chain, especially owing to its knock-on effect. Increasing environmental risk consideration will possibly lead to the current frameworks becoming constrained, necessitating development and expansion. Yet, this signifies that development is supported by the participants, and environmental risk will become a core business competency, developing from its initial mere peripheral concern.
Mimetic transparency and benchmarking
Environmental risk has already been included in various institutions through mimetic forces, as mentioned, but Participant F1 also quantified environmental risk management within the top 40 JSE-listed companies according to market capital. Twenty-nine of the top 40 companies had Key Performance Indicators (KPIs) for top management that were linked to ESG factors, and 38 out of 40 mapped their businesses according to 17 Sustainable Development Goals (SDGs). Twenty-five also incorporated TCFD reporting, and 35 out of 40 had net-zero emission targets. This further illustrates the mimetic transparency that is becoming apparent between institutions. This pre-emptive incorporation of environmental risk is also done to remain relevant in the near future, especially with policy and regulation updates.
Although the driving force to include environmental risk and the concurrent transparency it brings may have its foundation in mimetic isomorphism (Aerts et al. 2006), it is stated by the participants that development is still taking place in all industry markets. The uncertainty and expectation of regulations to set requirements in this regard also drive different institutions to mimic approaches even further (Aerts et al. 2006; Tolbert & Zucker 1996), potentially enabling faster dispersal of new approaches, although at varying levels depending on the institution (Han 1994).
Standardisation and use of scientifically proven methods
Our participants indicated that environmental risk management also serves as a proxy for the general management approach towards risks, as Participant B1 stated: ‘a company with a handle on their environmental risk is considered good at overall risk management’. Participants also expressed that, in addition to the reputational value that good environmental risk management has, they view good ESG scores as a proxy for good financial performance. Six of the 13 participants, representing four banks, emphasised that ESG reporting is already integral to their arrangements with clients, especially based on account or transaction size, with environmental risk considered equally to financial indicators in some sectors.
Participants also raised the issue that banks have started to quantify the emissions, and, in some cases, water use, biodiversity issues and air quality that are funded by them. This was seen in four of the six included banks. Banks also include external consultants and institutions such as South Africa’s Council for Scientific and Industrial Research (CSIR) to improve internal EMSs. A major motivating force for this is the expectation that other banks would start to report on their funded environmental risk, and consequently any banks not already acting with transparency about their environmental risk would suffer reputational damage (Gatzert 2015), thus linking it to the mimetic transparency discussed earlier. Improving the quantification of the environmental risk the bank is exposed to through its lending can also help reduce the time to respond, especially in the case of natural disasters such as the droughts in the Western Cape (Pienaar & Boonzaaier 2018) or floods in KwaZulu-Natal, also mentioned by two of the participant banks. This can impact banks in two ways. Businesses directly affected may incur losses (Daily Maverick 2022), but secondary impacts can also lead to losses in companies in other provinces as well, hence the need to track exposure to environmental risk across the entire transaction chain.
The participants agreed that environmental risk management is necessary within the banking sector, but individual banks cannot influence markets, consumer behaviour or national policies. In this regard, participant C1 stated that ideological barriers, especially between traditional political and financial groups, hinder progress. Participant A1 agreed, noting that slow policy development hampers effective transition management. Other participants also added that the current framework is inadequate because insufficiently quantifiable risks prevent an accurate allocation of capital. Regulatory processes also need to become more comprehensive to remove any uncertainty about the role of banks and their role in addressing environmental risk. Participant views showed that banks recognise the need to expand environmental risk management with broader policy and regulatory guidance and also to continue operating profitably in increasingly complex environments. Ultimately, this results in a conflict between sustainability and profitability within banks. The lack of standardised methods as well as uncertainty about the development of regulatory policies also allows for the possibility of greenwashing, a risk also identified by the participants.
The adoption of standardised approaches and the changing of the environment in which banks conduct their business is grounded in rational myth according to Institutional Theory (Meyer & Rowan 1977), where rationalised institutional rules become formal structures (Lammers & Barbour 2006). Consequently, although standardisation can be done in expectation of regulatory requirement, as mentioned, it also leads to formal organisational structures pre-empting this requirement, counterproductively removing the motivation for regulatory development.
Just transition institutional logic
Participants expressed the increasing expectation of banks to facilitate transition strategies to mitigate and adapt to climate change. This can be done with targeted funding and the banks’ focus on the transition of the different funded industries, as well as by improving the ability to accurately determine environmental risk. Banks experience the impact of increased environmental risk awareness as an increase in the Capital Adequacy Ratios (CAR), required under the Basel III framework. The consequence of this increased awareness is that it may lead to some clients not being eligible for financing, limiting some industries slower to transition to lower environmental risk, that is, coal-fired power plants that remain necessary for the economy. However, targeted funding can drive the transition to lower environmental risk through coercive pressure, as described earlier, that banks can impose on any financed industry (Martínez-Ferrero & García-Sánchez 2017), benefitting any industry able to manage their environmental risk.
Participants, however, unanimously expressed their ideal future for environmental risk consideration as a market-based model where the price of goods and services incentivises the sustainable choice, noting that the current pricing model is not adequate. The current limits do not allow for the incorporation of societal costs; thus, neither seller nor buyer is made to carry the failure of market externalities. Most participants agreed that the current ability to assess ‘sustainability’ or ‘greenness’ is limiting but listed the determination of environmental compliance as the absolute minimum baseline requirement for any consideration of a transaction or client. However, the lack of adequate environmental risk valuation results in long-term environmental risk pricing fluctuations as new or different data become available. This increasing consideration of environmental risk, and awareness of people in the industry, signifies the change in the institutional logic driving the inclusion of environmental risk through adjustment of how the institution does its business, causing a cascading effect throughout the structure thereof (Lammers et al. 2014).
Mainstreaming of environmental risk as discipline
A major concern of participants is that the current reporting model is merely administrative, with indices and standards not contributing to operational outcomes as a result of ambiguity between the institutions’ reporting standards. They believe that policies should focus more on scientifically verifiable information to improve reporting and balance environmental, economic and social dimensions. Reputational pressures and competition between the different institutions may help reduce the ambiguity between institutions, but this pressure may lead to evaluations focusing on certain issues, excluding other important environmental considerations. For example, habitat loss and biodiversity protection both have significant ecological impact but do not receive the same attention owing to their differing levels of economic and social value.
Another fear mentioned by the participants is that the expansion of environmental risk consideration could lead to unequal transitions to a lower environmental risk by businesses and clients, potentially stranding assets. Four of the 13 participants specifically mentioned the use of natural gas as an alternative fuel owing to its exemption from the GHG emission regulations. However, as also noted by Participant B1, South Africa does not have an extensive gas-handling infrastructure, so large investment will be needed to create a network. Financing these developments may be risky as wind and solar energy generators are potentially being deployed faster; hence, policies must be developed to manage the transition to alternative energy sources.
The majority of participants had the view that if they were unconstrained and had absolute authority, they would enable renewable energy sources to be incorporated faster to de-risk South Africa from economic export restrictions, aided by a deregulated energy market allowing for larger development of carbon offset opportunities. The transition to renewable energy sources must also be considered as significant socioeconomic opportunities for economic growth, job creation and carbon mitigation. This would allow for a shift in the approach to environmental risk that balances risks with opportunities afforded by the transition. Participants B1 and E1 specifically mentioned the opportunity that should be leveraged within the mining and manufacturing industry to produce resources and manufacture components needed for renewable energy. The banking sector itself will also be able to take advantage of carbon offset assets as an opportunity during the transition to renewable energy.
Although ESG is integral to most companies and banks, participants showed that there is no common framework for differentiating between the different levels of sustainability. This creates the opportunity for greenwashing where certain institutions, more lenient in their environmental risk evaluation, can be targeted by at-risk borrowers. The need to standardise through professionalisation within any industry is driven by normative isomorphism that is described under mimetic forces in Institutional Theory (Kılıç et al. 2021; Lammers & Barbour 2006; Lammers et al. 2014). While this is a valuable driving force, the standardisation and professionalisation sub-themes are interrelated. Although standardisation may be needed before professionalisation can be motivated, both these sub-themes are driven by the mainstreaming of ideas and behaviours within an industry (Martínez-Ferrero & García-Sánchez 2017; Ponnert & Svensson 2018). This will only continue, as additional institutions (even outside of the banking sector) incorporate similar approaches to environmental risk to further normalise and standardise the approach throughout the value chain.
International benchmarks should form the framework for the future environmental risk evaluation by financial institutions. Therefore, the ideal envisioned future, agreed by the participants, would include a system able to measure relevant factors that determine and quantify the sustainability of any decision made. This would require first that the EMSs that banks employ be able to contextualise the client’s activities and stress-test for sustainability. Secondly, the environmental impact assessment must be based on scientifically verifiable data, which depend on the expertise of professionals in the field. Thirdly, alignment between institutions is needed because of the current non-standardised method of determining sustainability. Fourthly, future risk should be incorporated into capital pricing, providing a market-based solution and preventing short-term profit from superseding environmental risk. Lastly, national sustainability and the transition to more sustainable solutions need defined and measurable targets from the relevant national departments to allow banks to align and motivate their funding decisions.
Conclusion
This research aimed to explore the perceived future of environmental risk consideration within the South African banking sector from the perspective of individuals in the industry.
The first objective specifically led to the exploration of the perspectives from insiders in the South African banking industry with regard to how they view environmental risk consideration in the industry. This led to the successful identification of sub-themes grouped under past, present and future, allowing for the structuring of a framework for the second objective. We also discussed how Institutional Theory underpins this development and has contributed to it in the different phases. It was evident that various drivers described under Institutional Theory act upon, and can explain, the sub-themes that emerged, but also that these drivers are not necessarily evolving similarly to the sub-themes, with the same drivers potentially acting in the past, present and future.
We conclude that banks will continue to pursue financial profits in a market-based environment as allowed within the regulatory framework. However, based on the research results, the following are key future challenges for dealing with environmental risks in the banking sector:
- Achieving alignment and standardisation: Despite continuing efforts to include environmental risk within the banking sector to drive transition to lower risk, policy objectives would have to be aligned, and the major lack of standardisation across governmental departments and different institutions in determining environmental risks will have to be addressed.
- Timely policy response: Local policy development and regulatory reform seem to continually lag market responses to environmental risks as well as international standards and risk obligations.
- Delivering market-based choices: The future should include consideration of environmental risks throughout the value chain with the development of alternative products. This should include a choice for both consumers and financial institutions, while enabling competitive development of alternative, low-environmental-risk alternatives.
The resulting framework shows that the drivers for environmental risk inclusion in the banking sector evolved over time, becoming more dependent and responsive to inter- and intra-industry reactions, although regulatory oversight and drivers remain important.
Acknowledgements
This article is based on research originally conducted as part of Louis J.R. Fourie’s master’s dissertation titled ‘Exploring the future of environmental risk considerations in the banking sector’, submitted to the Faculty of Natural and Agricultural Sciences, North-West University, in 2022. The dissertation is currently available in the institutional repository of the North-University at https://north.on.worldcat.org/oclc/1431180550. The dissertation was supervised by Reece C. Alberts. The manuscript has been revised and adapted for publication in the journal. The authors confirm that the content has not been previously published or disseminated and complies with the ethical standards for original publication.
During the preparation of this work, the authors used Writefull for Word, (2026, premium package), for grammar refinement and improved readability. The content was reviewed and edited by the authors who take full responsibility for its accuracy.
Competing interests
The authors, declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article.
CRediT authorship contribution
Louis J.R. Fourie: Conceptualisation, Formal analysis, Investigation, Methodology, Writing – original draft. Francois P. Retief: Conceptualisation, Methodology. Reece C. Alberts: Conceptualisation, Methodology, Project administration, Supervision. Dirk P. Cilliers: Conceptualisation, Methodology. Ruhan Verster: Visualisation, Writing – original draft. All authors reviewed the article, contributed to the discussion of results, approved the final version for submission and publication, and take responsibility for the integrity of its findings.
Funding information
The authors received no financial support for the research, authorship, and/or publication of this article.
Data availability
The authors declare that all data that support this research article and findings are available in the article and its references.
Disclaimer
The views and opinions expressed in this article are those of the authors and are the product of professional research. They do not necessarily reflect the official policy or position of any affiliated institution, funder or agency, or that of the publisher. The authors are responsible for this article’s results, findings, and content.
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