When the economic crash happened in 2008, many people lost faith in the financial system. Many linked the system with greedy bankers. Still, the reality was far from the image people had. While it is true that bank managers can make mistakes, they are also the ones encouraging the sustainability of the banking system, which is important in the long run.
However, bankers can do more to improve the services banks provide. For proper improvement, they must not consider that capital is just the final destination, but also a way to get to that destination. Financial institutions can help individuals and businesses reach their dreams and goals, but only if they promote green economy and not boom and bust as they do today.
Financial institutions should become responsible for their own actions, as they profoundly influence how capital is spent and whether it is used for sustainable and productive investments. Having such accountability is vital to ensure a stable financial system. However, there is also some risk that comes from misalignments, such as timescale and the view of risks connected to the banking system.
Instead of focusing on long-term objectives such as environmental protection, climate transition, job creation, and retirement financing, the financial system focuses on short-term ones and sometimes overlooks financial risks. This puts a lot of pressure on third parties that manage capital. To avoid this kind of pressure, individuals and companies have to consider looking at sustainability risks in the long term.
Investors should integrate actions against sustainability risks. Sustainability risk is a financially significant risk on the expected return on investment. Environmental, governance and social factors may have a financial influence on an investment or target firm itself, and the economic effect may be on both. Extreme weather conditions, withdrawal of licences to operate, corruption scandals, or poor governance practices are all possibilities.
Beyond these duties, coherent and simultaneous management of financial institutions and the agencies supervising them must take place. Actions taken by financial institutions must not stop there. Policies and regulations must be attuned to market-based tools that are used when making investment decisions, such as credit ratings and benchmarks. Developing these would lead to reduced risks and sustainable methods to face risks.
For the financial system to be sustainable, there is a need of achieving social inclusion, economic prosperity, and environmental regeneration. To achieve these goals, measures must be taken by the institutions, among others reduction of carbon emissions, or investments in human capital. Even more, decisions to protect the environment and boost social inclusion should be added to the financial institutions’ agenda.
Achieving sustainability is an imperative part of the system. To ensure it, financial institutions must put ESG factors at the heart of their decisions. Then they must invest their capital to sustain society by creating jobs, tackling inequality, or shifting to a decarbonized economy. Much has already been done, but to achieve their objectives, financial institutions have to go beyond the usual.
One way to do so is to achieve the UN sustainable development goals. For this, financial institutions have to come up with effective policy-making mechanisms. Furthermore, they have to not hold back progress, as they do now because their business models are not yet developed according to sustainability lines. Financial institutions also have to better understand what is required of them.
If current trends continue to happen, the financial system, as well as associated policy frameworks, gamble succumbing to that same ‘tragedy of the horizon,’ which occurs when the financial picture is short-term and hence ignores long-term issues such as global warming, demographic data, climate change, technology, or the rewards of long term investment, blinding banking firms and policymakers to their repercussions.
The corporations and financial organizations that want to make long-term projects are frequently constrained by short-term regulatory and market demands, and as a result, they underinvest in the necessary personnel, technological, and natural resources. The long-term initiatives, long-term risk materialization, together with their short-term market obligations, eventually end up suffering not because of anything, but as a result of maturity mismatches.
Banks play a significant role in sustainable lending as the European Union’s largest asset pool, but the overall level of sustainable investments has not been clearly established. Banks still continue to be the primary source of external financing for the majority of households and small and medium-sized businesses in the world, accounting for around 80% of green infrastructure financing in various places.
Sustainable infrastructure investments benefit economies by boosting productive capacity and economic growth rates while also enhancing resilience to resist and counter future challenges. In a general context, it refers to financial environments that reward long-term economic development instead of just inequality and exclusion. Financial institutions must promote a green economy rather than boom and bust and rather than damaging natural resources.