Environmental Risk Management and Environmental Risk Rating

Environmental Risk Management

Environmental Risk Management is for assessing environmental risks and not intended to squeeze investment; rather it is for sustainable finance. Environment management in the banking business is like risk management. It increases the enterprise value and lowers loss ratio as higher quality loan portfolio results in higher earnings. The financial sector as a whole could not comply with the implementation deadline with initial difficulties in applying those but has come forward under the umbrella of BB to promote and support green banking in Bangladesh. Traditionally banking sector’s concern for environmentally degrading activities of clients is like interfering or meddling in their business affairs. However, now it is being perceived that environmental hazard brings risks to their business. Although the banking and financial institutions are not directly affected by the environmental degradation, there are indirect costs to banks. Due to strict environmental disciplines imposed by the competent
authorities across the countries, the industries would have to follow certain standards to run their business. Credit risk can arise indirectly where banks are lending to customers whose businesses are adversely affected by the cost of cleaning up pollution or due to changes in environmental regulations. Credit risks are also associated with lending on the security of real estate whose value has diminished owing to environmental problems.

The ERM guideline prescribes a set of sector specific Environmental Due-diligence Checklist for financing environmentally sensitive sectors4 by banks. Banks/FIs should conduct a preliminary environmental risk review on each credit proposal using Environmental Due Diligence (EDD) checklists. There is one General EDD checklist, ten
Sector EDD checklists and a Guidance Matrix. Potential borrowers will have to submit various documents to the respective authority for obtaining the Environmental Clearance Certificate.
Banks/Fls need to obtain copies of these documents as the background for completing the EDD checklists. The outcomes of both the General and Sector specific EDD checklists are combined in the Overall Environmental Risk Rating (EnvRR). Finally, it is a ‘yes’ or ‘no’ decision for financing the proposed credit based on subjective judgment of High’ ‘Low or ‘Moderate’ EnvRR.
For High’ EnvRR the credit risk management should ensure that additional conditions/covenants are included. The EnvRR should be considered along with the overall credit risk rating of a proposed credit for financing decision. Environmental Risk Rating are required for all individual customers (corporate, institutional, personal, small
and medium enterprise) whose aggregate facilities are above BDT 2.5 million for SME, financing; BDT 10 million for Corporate, financing and BDT 10 million for Real estate financing.

Environmental Risk Rating

In the green banking policy, Phase-I, the environment risk management gets a privileged in credit risk management. In 2011, Guideline for environment risk management was introduced and in green banking policy the ERM is incorporated to minimize the environment risk. According to this guideline, banks/Fls are required to measure the environmental guideline). The ERM guideline, banks are supposed to place the high rated projects to the Board for approval. In most cases, banks do not have policies or guidelines for the approval of these high rated projects. The ERM guideline requires banks to establish and maintain a database of NPLs due to environmental reasons and to have a reporting system on an annual basis.