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ESG risk management, explained: Why It’s Important

Victoria Ebel, Appian
March 27, 2023

In the banking and financial services industry, ESG (environmental, social, and governance) concerns now figure in many aspects of business strategy, including risk management. Indeed, ESG risk management has become a key aspect of banking operations. Let’s examine the key risks and how automation technologies can help banking leaders address them.

What are ESG risks?

ESG risks relate to climate risks, social risks, and corporate governance issues that can affect a company's financial performance and reputation.

  • Environmental risks can arise from factors like pollution, climate change, and deforestation. For example, a company that emits a large amount of greenhouse gasses may face regulatory fines or physical risks as the world becomes more concerned about climate change.
  • Social risks can arise from a company's engagement with social issues, such as human rights, labor practices, and community relations. For example, a company that uses child labor may face reputational risks or legal action.
  •  Governance risks can arise from a company's corporate governance practices, such as board composition, executive compensation, and accounting practices. For example, a company with poor corporate governance may be more susceptible to fraud or financial mismanagement.

[ Discover how to effectively execute your ESG risk management framework: Get the eBook. ]

Why is ESG risk management important?

ESG risk management is essential for several reasons. First, managing ESG risks can help protect a bank's reputation. Banks that are seen as responsible and sustainable are more likely to attract and retain clients. Second, managing ESG risks can help with financial stability. ESG risks can lead to financial losses, litigation, and regulatory fines. By identifying and managing these risks, banks can reduce the likelihood of financial losses. Finally, managing ESG operational risks is important for the long-term sustainability of the banking industry. As the world becomes more focused on sustainability, banks that fail to manage ESG risks will find it increasingly difficult to attract and retain clients.

3 key roles of technology in ESG risk management.

Risk management teams must deal with a high volume of complex risks related to ESG criteria, coming at a high velocity. These risks are typically managed across different business silos using separate methodologies, measurements, and data.

Banks can leverage tech solutions to break down these business and data silos. With the right capabilities, banks can standardize and automate processes to collect and analyze data, identify potential risks, and monitor their exposure to these risks. Here are some examples of how technology can help manage ESG risk in banking:

Data collection and analysis.

Process automation can streamline the data collection process by identifying and correcting errors and inconsistencies to correct and standardize the data. This can help ensure that data is consistent and easy to analyze. Automation capabilities can then help banks analyze large volumes of ESG data quickly and accurately. For example, banks can use AI technologies to identify patterns and trends in ESG data to catch potential risks.

AI also plays a role within a process automation platform by helping avoid challenges that arise when an organization uses multiple automation solutions that don’t communicate well. This is especially key as you try to scale automation and ESG efforts. 

Risk identification and reporting.

Data fabric technology can help banks integrate data from multiple sources and create a unified view of ESG risk data. For example, banks can use data fabric to integrate ESG data with financial data, which can provide a more comprehensive view of a company's overall risk profile.

In practice, ESG data sets are large, complex, and tough to analyze. This is where a data fabric can play a critical role, breaking down data silos and allowing an organization to seamlessly connect ESG data from disparate departments and software systems.

Data fabric creates a unified, real-time view of the data with which users interact while leaving that data in its source system. That’s especially important for banking and financial organizations, since they deal with a high number of legacy systems and some of the world’s most complex and heavily regulated processes, like Know Your Customer (KYC).  

[ Want to learn more about how to solve your data silo problems? Get the eBook: The Data Fabric Advantage. ]

With a process automation platform that seamlessly interfaces with existing systems, databases, and third-party providers, risk teams can generate ESG reports based on processed information, key figures determined by the system, or manually recorded figures. This creates visibility into key performance and key risk indicators and gives transparency to all stakeholders.

Risk monitoring.

Banks can use technology to monitor their exposure to ESG risks. Automation enables risk teams to rapidly create frameworks that evaluate risk and control maturity according to chosen industry and internal guidelines. Risk managers can also initiate, assign, escalate, and recertify exemptions through case management capabilities.

ESG risk management is now an essential aspect of banking operations. By managing ESG risks, banks can protect their reputation and mitigate financial risks. As the world becomes more focused on sustainability, banks that effectively manage ESG risks are the ones that will experience lasting success.

To learn more about ESG strategy and tools, get the eBook: Sparking Change: How Financial Groups Can Galvanize ESG Efforts.