Real Economy Real Returns:

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1 Real Economy Real Returns: A Scorecard for Sustainability Banking 22 October 2015 David Korslund, Senior Advisor

2 Welcome and overview Global Alliance A Brief History Research on Bank Performance The Global Alliance Scorecard Questions Slide 2

3 Global Alliance A brief history Banks that put people before profit Supporting individuals and enterprises in their local communities delivering: Economic resiliency Environmental regeneration Social empowerment Slide 3

4 Principles of Sustainable Banking Slide 4

5 Global Alliance The first three years 2009: 12 founding members in Zeist a global movement of banks from the beginning 2010: Strategy set in Dhaka with focus on four key elements Human Capital Financial Capital Metrics Advocacy 2011: Plans made concrete in Lima for each element Slide 5

6 Global Alliance 2012 to : Research released in Vancouver highlighting business case for banking based on Principles of Sustainable Banking 2013: Declaration in Berlin with demands on bank sector: Transparency, Sustainability, and Diversity 2015: Melbourne develops further details on delivering long term elements of plan 2015: Paris launch of SFRE and Leadership Academy to enhance financial and human capital Slide 6

7 Slide 7

8 2015 Research Update Findings first released in Vancouver continue to hold Compared Global Alliance Growing support from external studies BIS study on over financialisation Shared value results from FSG IFC and developing markets central banks support for sustainability principles University of Chicago study on value of finance Number of commentaries in the Financial Times Slide 8

9 Real Economy Real Returns: The Power of Sustainability Focused Banking Compares Global Alliance members (SFBs) with largest banks in the world (GSIFIs) Answering four questions: What support does a bank provide to the real economy? How resilient is a bank in the face of economic challenges? What returns does a bank provide to society, clients and investors? What growth does a bank achieve to expand its impact? Slide 9

10 Money at Risk Exposure The core banking activity is intermediating between providers and users of capital by managing Money at Risk Exposures Allocation of Money at Risk across the Real Economy and Financial Economy and to Triple Bottom Line activities reflect a bank s priorities and hence its sustainability focus Classifying Real Economy and Financial Economy Money at Risk Exposures is therefore crucial to determine a bank s business model focus Slide 10

11 Real Economy: Definition The real economy relates to economic activities that generate goods and services as opposed to a financial economy that is concerned exclusively with activities in the financial markets. Degrees of separation key concept to differentiate the focus of banks between the real economy and the financial economy Slide 11

12 Degrees of Separation Financial instruments should be classified Real Economy if they are no more than one degree from a Real Economy Asset or Activity. A specific type of financial instrument could be in different categories depending on its actual use by the banking institution. Real Asset/ Activity One degree Two degrees Three degrees Four degrees Real Economy Financial Economy Slide 12

13 Degrees of Separation Real Asset/ Activity One degree Two degrees Three degrees Four degrees Real Economy Financial Economy Financial instruments with fewer degrees of separation from the Real Economy demonstrate Transparency and closer Client Partnerships Transparency Client Partnerships Slide 13

14 Support to the Real Economy Current bank financial reporting does not explicitly provide real economy exposure. Therefore exposure to real economy was estimated by ratios of Loans and Deposits to Total Assets SFBs show substantially higher exposure to the Real Economy Loans / Assets SFBs 75.2% 77.0% 75.7% 73.0% GSIFIs 39.6% 39.4% 39.8% 41.8% Slide 14

15 Support to the Real Economy Current bank financial reporting does not explicitly provide real economy exposure. Therefore exposure to real economy was estimated by ratios of Loans and Deposits to Total Assets SFBs show substantially higher exposure to the Real Economy Deposits / Assets SFBs 78.0% 76.0% 71.6% 73.9% GSIFIs 49.0% 46.1% 43.6% 45.1% Slide 15

16 Financial Resiliency SFBs have consistently maintained high capital positions in terms of Equity to Total Assets Equity / Total Assets SFBs 7.9% 8.0% 7.3% 6.4% GSIFIs 6.9% 6.1% 5.0% 4.9% Slide 16 Tier 1 Ratio SFBs 12.7% 12.1% 11.3% 11.5% GSIFIs 12.7% 12.4% 10.2% 8.3%

17 Financial Resiliency GSIFIs and SFBs have comparable Tier 1 Ratios in 2014 but ratio of RWAs to Total Assets highlights impact of RWA models Tier 1 Ratio SFBs 12.7% 12.1% 11.3% 11.5% GSIFIs 12.7% 12.4% 10.2% 8.3% Slide 17 RWA / Total Assets SFBs 61.8% 62.9% 60.7% 53.2% GSIFIs 44.5% 40.3% 42.2% 49.2%

18 Financial Returns Return on Assets is a critical measure of a bank s performance Starting in the crisis year of 2008 SFBs consistently outperform GSIFIs with lower volatility RoA 0.9% 0.8% 0.7% 0.6% 0.5% RoA 5y ( ) Average St. Dev. SFBs 0.60% 0.17% GSIFIs 0.50% 0.18% SFBs 2010 GSIFIs % 0.3% 0.2% 0.1% 0.0% RoA 10y ( ) Average St. Dev. SFBs 0.63% 0.24% GSIFIs 0.52% 0.38% Slide 18

19 Financial Returns Return on Equity is influenced by amount of leverage Even with less leverage SFBs outperform GSIFIs with less volatility over the full cycle RoE 18.00% 16.00% 14.00% 12.00% 10.00% RoE 5y ( ) Average St. Dev. SFBs 7.9% 2.3% GSIFIs 7.7% 2.9% 8.00% 6.00% 4.00% RoE 10y ( ) Average St. Dev. 2.00% 0.00% SFBs 8.4% 2.8% SFBs GSIFIs % GSIFIs 8.9% 8.7% Slide 19

20 Growth of Impact SFBs show much higher growth when compared to GSIFIs. Total Loans From 2005 From 2010 SFBs 12.4% 12.2% GSIFIs 7.5% 5.4% Total Deposits From 2005 From 2010 SFBs 12.4% 12.0% GSIFIs 8.7% 5.9% Slide 20 Total Income From 2005 From 2010 SFBs 9.5% 9.1% GSIFIs 5.7% 6.8%

21 Global Alliance Scorecard Developing a standardised method to assess and report a bank s performance on social, environmental and economic criteria is a key challenge for the Global Alliance The research provided a solid foundation for approaching this issue although focused on financial measures The practitioner knowledge among Global Alliance members has developed the Scorecard to meet this challenge going beyond financial to create a holistic tool Slide 21

22 Uses of Scorecard Self Assessment Stakeholder Communication External Assessment Industry Standard Standard for reviewing business model compliance with Principles of Sustainable Banking Structured approach to inform variety of stakeholders Useful tool for investors and others to make choices among banks Potential as the global banking standard Slide 22

23 Scorecard Structure Basic Requirements Quantitative Factors Qualitative Elements Sustainability Score Regulated Banking Institution Sustainability Mission Transparency Financial Viability Real Economy Focus Triple Bottom Line Focus Strategic Direction Implementation Identifiable Results STOP GO Base Sustainability Score Sustainability Score Calibration Slide 23

24 Scorecard Assessments Sustainability Score Established : Financial institutions that already demonstrate, through their business models, internal practices and results, an authentic and thorough commitment to embedding sustainability into their banking model to meet the needs of their communities. Engaged: Financial institutions whose leadership has embraced the sustainability-focused banking model and have made concentrated efforts to steer the organization in this direction, though its products and internal practices lack full realisation. Emerging: Financial institutions whose management is convinced of the power of a sustainability focused banking model and has the sincere intention and initial actions for steering its institution towards the adoption of sustainability-focused banking products and services. Slide 24

25 Basic Requirements STOP GO Regulated Banking Institution Statement regarding regulatory framework and status and evidence of client deposit and lending relationships Mission Statement Institution s mission statement has elements related to at least one of the Principles of Sustainable Banking Reporting Transparency Evidence of transparency of reporting to all stakeholders, especially relative to sustainability commitments Slide 25

26 Research Provides Basis for Scorecard In developing Scorecard the research provided the basis for key aspects of Quantitative Factors Real Economy measures for money at risk exposures and client based funding Performance of Return on Assets Strength of Capital position for resiliency Slide 26

27 Quantitative Factors Overview The Quantitative Factors provide insight into three elements Financial Viability, Real Economy Focus and Triple Bottom Line Focus addressed in the Principles Triple Bottom Line Focus 40% Financial Viability 35% Real Economy Focus 25% Slide 27

28 Quantitative Factors Financial Viability Financial Viability (35%) has several sub-components consisting of key financial ratios: Deposits/ Assets, 10% Asset Quality Ratio, 5% Return on Assets, 10% Earnings/ Assets, 10% Slide 28

29 Money at Risk Exposures in 3-D In assessing the allocation by a banking institution of its Money at Risk Exposures, there are three independent dimensions to consider: 1) On or Off Balance Sheet 2) Financial Economy or Real Economy 3) Triple Bottom Line or Non-Triple Bottom Line TBL Non- TBL Financial Economy Real Economy Off Balance Sheet Slide 29

30 Quantitative Factors Triple Bottom Line Money at Risk Exposure should positively contribute to at least one Triple Bottom Line without negatively impacting any other Triple Bottom Line: People: social empowerment Planet: environmental regeneration Prosperity: economic resiliency Money at Risk may meet more than one of these Triple Bottom Lines Slide 30

31 Qualitative Elements What to Cover QE1 QE2 QE3 QE4 QE5 QE6 Leadership Organizational Structure Products & Services Management Systems Human Resource Tools Performance Reporting Slide 31

32 Qualitative Elements Show the Flow A holistic Flow from High Level Direction to Identifiable Results provides grounding to the commitment to the Principles of Sustainable Banking QE1 QE2 QE3 QE4 QE5 High Level Direction Why? Implementation and Processes How? Identifiable Results QE6 What? Slide 32

33 Qualitative Elements - Examples Strategic Direc5on Implementa5on Iden5fiable Results Performance Reporting Bank will be transparent in reporting on its activities All lending clients requested to allow publication of financing Detailed information on 95% of all loan clients available on bank website Products & Services Bank is committed to financing only sustainable clients All clients to be assessed using a standard tool relative to client sustainability 40% of clients have top assessment. 10% of clients had inadequate assessment Human Resources Tools Bank is committed to relative equality of compensation Human Resources to ensure that ratio of highest to lowest pay is relatively equal Ratio of Top 10% compensated staff to Lowest 10% was 2.3 Slide 33

34 Scorecard Summary Holistic approach using qualitative and quantitative facts Developed by banking practitioners Suitable for all banks Grounded in research Slide 34

35 Questions? Global Alliance for Banking on Values David Korslund Slide 35