Rippled nature reflection on pond water surface
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From financing polluting companies to their own employees’ misconduct, environmental, social and governance (ESG) risks are becoming increasingly significant for banks, Moody’s Investors Service says in a new report.

The rating agency says that ESG risks are becoming more important to banks from a credit perspective, as these considerations can affect its assessment of asset quality, capital strength, profitability, liquidity and funding.

Banks are exposed to ESG risks both directly, through their own activities, and indirectly, through their loans and investments, Moody’s says.

“For example, climate change may undermine the repayment capacity of borrowers in carbon-intensive or weather-dependent sectors, reducing both asset quality and profitability,” Moody’s says.

The report also notes that ESG risk varies by market.

For example, it says, the risk of misconduct litigation is greater in developed markets that have stricter consumer protection laws, while environmental risk is greater in developing countries.

“ESG risks are not new, but they are becoming more significant for banks due to changes in regulations, government policy, social attitudes and market developments,” says Alberto Postigo, vice president and senior credit officer at Moody’s.