Mind the Governance Gap: Banks Gilding the Sustainability Lily

As financial regulations close in on banks, CSR researcher Martijn Boersma, from Catalyst Australia, explores why they are still allowed to self-regulate on social and environmental issues.

The GFC has shown that unsustainable banking activities can bring the economic system to the brink of collapse. A new report by Catalyst Australia examines to what degree banks can also cause, or alternatively mitigate, social and environmental harm, and the resulting responsibilities towards the community and the environment.

Confidence in banks is low – a national survey found that 76 per cent of respondents believe that banks put profits before their social and environmental responsibilities. Only 26 per cent of respondents believe banks will behave ethically and responsibly if they regulate themselves.

These figures show the widespread mistrust of banks, and raise doubts about the appropriateness of social and environmental self-regulation.

In the aftermath of the GFC, regulators increased supervision and became less trusting of self-regulation. So why can banks continue to self-regulate social and environmental matters, while financial regulation is becoming stricter?

Self-regulation aimed at socially and environmentally responsible practices and outcomes in the Australian and global banking sector have largely resulted in symbolic outcomes. Although banks have created a responsible corporate image, further probes reveal many contradictions and shortcomings.

Short-termism has long been the norm in the financial sector. A sustainable bank would consider financial, environmental and social factors, while aligning its own interests with that of the community through long-term financial and non-financial value creation, for shareholders and stakeholders alike.

Banking products and services have a two-faced nature however. While stakeholder engagement is often quoted, it is accompanied by many examples where stakeholders are disadvantaged. The implementation of sustainability in governance systems is inadequate, suggesting that social and environmental matters are of limited concern to leadership.

There are also doubts about how banks address information asymmetry.

In a commercial transaction there is the risk of a party abusing superior knowledge. Similarly, inadequate social and environmental information can misinform stakeholders.

Despite the extensive uptake of reporting tools among Australian and global banks, increased disclosures have not prevented environmental, social and governance controversies. In many cases, stakeholders only become aware of unsustainable activities following reports by civil society organisations.

Risk-taking has the capacity to endanger the financial system. Yet, risk does not only concern financial elements, but also society and the environment.

While banks frequently mention risk assessments, they nevertheless continue to finance unsustainable activities. The adoption of voluntary codes comes at little cost and does not increase accountability, allowing for business to resume as usual. Voluntary initiatives of banks do not represent a strong commitment to reduce social and environmental risk levels.

The self-regulatory paradigm has created a governance gap that needs to be bridged by integrating corporate social responsibility in authoritative governance frameworks.

Yet the argument is not simply to expand the role of public law and authority.

Business is subject to three distinct but interrelated governance systems; public law and authority, a non-state system revolving around civil society and stakeholders, and the system of corporate governance – where the latter reflects the requirements of the previous two, albeit to varying degrees.

Increased convergence would help make social and environmental matters more enforceable and thus make companies more accountable, diminish the use of sustainability disclosures as a public relations tool, lead to the development of valid performance indicators, streamline disclosures, increase comparability, and ultimately improve social and environmental performance.

Substantial steps are reformulating directors’ duties to include social and environmental responsibilities, redefining sustainability reporting requirements and enshrining these in corporate governance, and founding social and environmental risk assessments on the precautionary principle, which shifts the burden of proof towards those parties that potentially cause harm.

It should not merely be the existence of regulation that prompts responsible corporate behaviour, but the dynamics between organisational culture, industry standards, institutional settings, and public scrutiny.

About the author: Martijn Boersma is a researcher at the Centre for Corporate Governance at the University of Technology Sydney, which aims to align the interests of individuals, corporations and society. He also works for Catalyst Australia, a progressive policy institute and think tank.