What is ESG ? Why is ESG important for NBFCs?
Environmental, Social, and Governance (ESG) norms are being increasingly viewed as an important factor in how NBFCs are perceived by stakeholders. This blog talks about ESG and also covers in detail why it is important for NBFCs.
NBFCs play an essential role in the economy by financing small businesses and households while reaching out to last-mile-consumers to give them access to credit. However, they are also exposed to several emerging risks such as Reputational Risk, Compliance Risk, Human resource Risk, and Climate-related Transitional & Physical Risks among other existing risks including credit risk, interest rate risk, and liquidity risk.
ESG (environmental, social, and governance) factors can help to mitigate these emerging risks and create value for NBFCs.
What Does ESG Stand For?
- Environmental factors refer to the impact of the company’s operations on the environment, such as its carbon footprint and efforts to reduce it.
- Social factors refer to the company’s impact on society, such as its labor practices, diversity, and community involvement.
- Governance factors refer to the company’s corporate governance policies, such as executive compensation, shareholder rights, and board structure.
ESG factors are therefore important considerations for NBFCs when it comes to managing risks and creating value. In this blog, we will access more about ESG factors and how they will play a role in terms of both, providing value to NBFCs themselves while also extending help to external entities.
NBFCs that adopt ESG practices take into account the environmental and social impact of their activities when making decisions about how to run their businesses. This can include initiatives like reducing emissions, investing in renewable energy, supporting local communities, and providing fair and safe working conditions for employees.
By doing this, NBFCs can help to create a more sustainable and responsible business model that benefits both society and the environment.
Why is the need for ESG increasing for NBFCs?
The growth of the NBFC sector in India has been driven by many factors, including the increasing demand for credit from businesses and households, the expansion of the financial sector, and the liberalization of the Indian economy. However, the recent slowdown in the economy and the deteriorating asset quality of some NBFCs have raised concerns about the sector’s resilience.
Given the risks faced by the sector, there is an increasing need for NBFCs to adopt strong ESG (environmental, social, and governance) practices. ESG factors can help NBFCs manage risks more effectively and create long-term value for shareholders.
One of the instances how Non-Banking Financial Companies can handle it well is by adopting strong environmental and social practices that can mitigate the impact of climate change and other social risks. In addition, by adopting strong governance practices, NBFCs can improve their risk management and corporate governance.
Integrating ESG In Financing Decisions
NBFCs should adopt a sustainability policy along with systems and procedures to ensure that the company’s financing decisions take into account that the borrower’s business activities comply with all applicable environmental laws and regulations thereby minimizing environmental impact and promoting sustainable development. By focusing on organizations that work in the field of environmental/ sustainable products or directly funding environment-friendly initiatives, NBFCs can help in the promotion of climate-friendly practices.
NBFCs have an important role to play in financial inclusion in India by targeting last-mile consumers covering people living in tier-3 or rural areas. Lending money to economically backward consumers who do not have access to a good credit score provides a massive growth opportunity in this sector considering a vast potential customer base and simultaneously increasing the living standards and alleviating poverty. NBFCs are major providers of micro-credit loans with an amount of ₹21,381 crores which accounts for 11% of the total industry portfolio, as reported by Microfinance Institutions Network.
Moreover, by refraining from financing activities that pose social threats e.g. human rights violations, child/ forced labor employment, inadequate labor payments, discriminatory employment practices, and unsafe working conditions, NBFCs can avoid their exposure to social and regulatory risks.
NBFCs have a comprehensive and robust governance framework for their organization. To ensure that all the stakeholders including the shareholders, customers, employees, creditors, and regulators are aligned with the organization’s objectives. The governance framework will also help the NBFCs to mitigate risks, improve decision making and build a sustainable business. Checking & assessing ESG factors in the course of lending will reduce NBFC’s exposure to financial and reputational risks.
ESG practices can help an NBFC in terms of both internal and external aspects. Be it improving their internal efforts to direct funds for better environmental sustainability or giving credit accessibility to last-mile consumers through a systematic framework. NBFC can utilize its targeted initiatives to enhance its ESG performance in line with globally benchmarked ESG practices and continue to be amongst the top-rated/ ranked organizations in ESG.