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The level of environmental and social risk will vary greatly for different types of financial transactions and by industry sectors. It can also be determined by factors such as scale and location and magnitude of potential environmental and social impacts.

To help a financial institution to determine the extent of environmental and social due diligence that will be required for a particular transaction, financial institution staff should assign a environmental and social risk category to each transaction. This provides an initial assessment of the environmental and social risk associated with the transaction. Together with the findings of the environmental and social due diligence, this environmental and social risk category can be incorporated into the overall risk assessment of a transaction and factored into the decision-making process.

The financial institution should develop a environmental and social risk categorization system to assign a environmental and social risk category to every transaction in a systematic and consistent manner. A typical system includes three environmental and social risk categories, designated as high, medium and low risk (or other similar terms such as A, B and C or 1, 2 and 3) representing different risk levels:

  • High Risk: Transactions typically involve clients/investees with business activities with significant adverse environmental and social impacts that are sensitive, diverse, or unprecedented. A potential impact is considered sensitive if it may be irreversible (such as loss of a major natural habitat), affect vulnerable groups or ethnic minorities, involve involuntary displacement and resettlement, or affect significant cultural heritage sites.
  • Medium Risk: Transactions typically involve clients/investees with business activities with specific environmental and social impacts that are few in number, generally site-specific, largely reversible and readily addressed through mitigation measures and international best practice. Potential adverse environmental impacts on human populations or environmentally important areas are less adverse than those of High Risk transactions.
  • Low Risk: Transactions typically involve clients/investees with business activities with minimal or no adverse environmental and social impacts.

The financial institution can also assign Financial Intermediary (FI) as a risk category to those transactions involving clients such as banks, microfinance institutions, private equity funds, and leasing and insurance companies, which act as financial intermediaries in making financing available to other clients. By assigning the FI Category, the environmental and social risks related to these types of transactions can be managed accordingly.

A environmental and social risk categorization system enables a financial institution to monitor and evaluate its exposure to environmental and social risk aggregated at the portfolio level. A financial institution can set internal threshold levels for its overall exposure as a function of environmental and social risk category or by exposure to industry sector or transaction type as a function of environmental and social risk category. This allows the financial institution to better manage and track changes in the overall risk profile of its portfolio and the associated environmental and social impacts of its clients/investees. This information can also be used by the financial institution to report internally to Senior Management and externally to stakeholders on overall environmental and social performance.


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