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The scope of financing activities of banking institutions may encompass transactions that target corporate finance, housing, project finance, retail, short-term finance, and small-medium enterprises.

The environmental and social risks will be more significant for corporate or project finance transactions, which are typically of large size and long duration and usually finance clients whose operations are complex and have potentially high environmental and social impacts. The environmental and social risks will typically be smaller for short-term finance transactions or transactions that support the activities of small-medium enterprises. For transactions that support housing (excluding construction) and retail, the environmental and social risks are generally considered to be non-existent.

As a starting point, a banking institution should review its current portfolio according to transaction types and exposure to the different industry sectors in which its clients/investees operate. The banking institution will apply the environmental and social risk management procedures to each transaction as part of its overall risk management framework. These procedures will be more substantial if transactions carry higher environmental and social risk and will require more in-depth environmental and social analysis on a project-by-project basis. For transactions involving lower environmental and social risk, a more simple procedure for screening transactions will be sufficient.

A banking institution’s ESMS will include the following components:

  • Environmental and social policy. The policy will state the banking institution’s commitment to managing environmental and social risks to which it might be exposed to as a result of transactions and clients in its portfolio. Typically, this will include a commitment not to finance certain types of activities, and requirements for clients/investees to comply with environmental and social regulations and also international standards for certain high risk transactions.
  • Transaction screening and risk categorization. The banking institution will screen all transactions to determine if it will proceed with a given transaction. It may categorize these according to low, medium or high environmental risk to determine the scope of the environmental and social due diligence that will be necessary to identify risks. This will enable the banking institution to prioritize transactions and focus on those clients that represent high environmental and social risks.
  • Environmental and social due diligence. The banking institution will conduct a environmental and social due diligence for each transaction but the level of detail will vary by transaction and will be based on the environmental and social risks identified during screening. For low-risk transactions, such as housing and retail, the extent of the environmental and social assessment will be limited to a simple review of the client’s operations to confirm that financing will be used for its intended purpose. For medium-risk transactions, such as short-term finance and to support small-medium enterprises, the environmental and social assessment will need to include an overview of the client’s operations, which may require a site visit, to identify potential environmental and social impacts due to the client’s industry sector. Environmental and social impacts of this scale are typically regulated under a country’s environmental and social regulatory framework and the banking institution will need to satisfy itself that the client complies with all applicable regulatory requirements. For high-risk transactions, such as corporate or project finance, a more in-depth assessment against environmental and social requirements will be necessary to fully understand potential environmental and social risks associated with the client’s operations. This will require a site visit and depending on the complexity of the client’s operations and industry sector, the banking institution should retain the services of an external expert.
  • Corrective action plan. Based on the findings of the environmental and social due diligence or during subsequent monitoring of the client’s performance, the banking institution may require clients to implement certain mitigation measures within a specified timeframe.
  • Environmental and social covenants. The banking institution may incorporate the corrective action plan and other environmental and social requirements as clauses in the legal agreement with the client. The scope of environmental and social clauses will depend on the transaction and the client’s operations.
  • Monitoring environmental and social performance. The banking institution may monitor the compliance of clients with its environmental and social requirements. The scope of monitoring will depend on the transaction and the client’s operations and can include periodic site visits.

For a banking institution, decision-making may be centralized or delegated at the branch level depending on the transaction size. The ESMS needs to define the roles and responsibilities of staff involved at each stage of the decision-making process and will typically include an ESMS Officer with oversight of the Environmental and Social Management System and an ESMS Coordinator for the day-to-day implementation of the ESMS.

Loan Officers will typically request from the client the necessary environmental and social information, which will be reviewed by Credit Analysts. For corporate or project finance transactions with high environmental and social risks, a banking institution may hire an external environmental and social specialist to conduct the environmental and social due diligence. The environmental and social findings and recommendations should be considered by the Credit Committee during the decision-making process for proceeding with a transaction.

A banking institution will need to ensure that a system is in place for record-keeping on environmental and social issues associated with each transaction as well as ensure that its staff is adequately trained to follow the procedures and identify E&S risks according to their roles.

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