Group 2

Opinion: Facing Covid-19 through the real economy


31 March 2022

By Adriana Kocornik-Mina, Senior Metrics and Research Manager, Global Alliance for Banking on Values


During Covid-19, values-based banks have been closer than ever to their customers while continued outperforming the biggest banks in the world, according to annual research “2021 Real Economy-Real Returns: The Business Case for Values-based Banking”.

The Covid-19 health crisis has directly affected more than 400 million people and indirectly impacted many more lives. Estimates indicate that 65 million to 75 million people might have entered into extreme poverty in 2020 alone. In many countries, the number of excess deaths over and above the historical average represents an increase of more than 50 per cent. And restrictions on face-to-face interactions have resulted in significant reductions in both demand and supply. These, together with disruptions in labour markets, production and supply chain bottlenecks alongside difficulties in global energy markets, shipping and transportation constraints, have meant that the impact on the real economy activity has been significant. Estimates of the effect on global economic growth in 2020 point to an annualised rate of around -3.2%. Excess mortality further adds to these costs to society in the form of longer-term impacts on physical and human capital.

From a real economy perspective, the immediate priority of many economic actors at the onset of the pandemic was to survive for long enough to recover eventually. Credit expansion policies that started in the aftermath of the 2008 financial crisis were accelerated in the wake of lockdowns to address immediate effects on companies, particularly Small and Medium Size Enterprises (SMEs). Additional policy responses included the deferral of taxes and payments, loan guarantees, direct loans and grants, and wage subsidies. These responses mainly implied “give money now and check later“, heavily relying on financial institutions willing to act to accommodate the surge in liquidity demand. However, globally the intended lending largely failed to materialise.

Lending to the real economy
Values-based banks lent to the real economy 30% more of their total assets on average than mainstream banks.

Facing Covid-19 through the real economy

Yet, values-based banks have been both willing and well placed to address Covid-19-related challenges. Having historically met the very real banking needs – especially access to credit – of enterprises and individuals within their communities, values-based banks chose to react to the pandemic’s uncertainty and risk very differently from their conventional counterparts. For example, they provided access to banking services for clients investing in expanding basic digital services and participated extensively in government support programmes. Values-based banks have not only supported clients and communities but protected co-workers while sustaining stable financial returns.

While government support programmes have helped eligible financial institutions offer more credit support and alleviate losses, exiting them, unless carefully managed, may undermine the recovery, according to an update by the OECD. Citing an uncertain economic outlook, banks have tightened lending. Once again, this appears not to be the case for values-based banks. In a survey conducted by the Global Alliance of Banking on Values (GABV) among their member CEOs in the Fall of 2021, more than half of the 52 respondents reported loan growth of more than 5% in the first half of 2021. In terms of deposit growth, more than 70% of respondents observed at least a 5% growth.

Values-based banks focus on the real economy, related to economic activities that generate goods and services as opposed to a financial economy that is concerned exclusively with activities in the financial markets. While disruptions to the real economy remain unevenly distributed both within and between countries, the impact on the financial markets has been comparatively short-lived. The S&P 500 Index, which lost one-third of its value in February and March 2020, had fully recovered by August 2020. Nevertheless, the challenges posed by the historical health crisis have resulted in a flurry of research ranging from disruptions in financial markets to shocks to the real economy.

Unprecedented financing in an environment of excess liquidity from central banks has contributed to excessive corporate leverage and high market valuations. But increases in money supply have not translated into corresponding investments in the real economy, as indicated above. Disconnects between the performance of stock markets and the real economy have been seen before, not least in 2014, when the commitment of the US Federal Reserve to quantitative easing further stimulated asset prices. In a global pandemic with high societal costs, financial markets alone have not succeeded in revitalising an inclusive and sustainable real economy. The 2020 Social Progress Index anticipates a delay in achieving the Sustainable Development Goals to 2082, over 50 years after the 2030 target date, and another decade more due to the Covid-19 pandemic.

ESG under observation

The scale and complexity of global challenges, including climate change, biodiversity and ecosystem degradation, and rising inequality, call for a wholesale transformation of economic systems to operate within a ceiling of planetary boundaries and a social floor that describes economist Kate Raworth in her Doughnut Economy theory. Such large-scale reallocation requires stakeholder participation and commitment to an inclusive and sustainable economy. Government action and a more fundamental transformation of markets to sustainability are needed. To this end, many are turning to ESG or Environmental, Social and Governance integration in decision-making. However, despite its rapid rise, the effectiveness and transformational potential of ESG investing has been questioned. As with the calls for stakeholder capitalism, the ESG industry has yet to deliver widespread behavioural change.

Critics argue that ESG investing is primarily, sometimes wholly, driven by a search for financial returns and does not drive or deliver the kind of expected change to the fundamental inequities and environmental challenges. Besides, if driven mainly by financial considerations, the expectation of low returns might halt capital shifting towards companies that try to do the right things. Tariq Fancy, a vocal critic of ESG, has gone further to question the extent ESG factors can contribute to sustainability, setting aside the risk of greenwashing. The battery of regulatory initiatives to manage climate and environmental risks and address the impact of climate change on financial stability across the globe will not be enough without a coherent approach to integrating ESG factors in decision making. It will also require profound changes in banks’ business models to reflect values-based banking best practices.

Loans growth VBB compared to GSIB 2021
The loans growth in values-based banks in the last decade is three times the biggest banks’ percentage.

Initiatives to face climate change from the financial system

The establishment of a Network of Central Banks and Supervisors for Greening the Financial System (NGFS) in 2018 recognised environment and climate challenges as opportunities and vulnerabilities for financial institutions and the financial system. Environment and climate risk management and the need to mobilise mainstream finance to support the transition toward a sustainable economy are two areas of focus of the NGFS.

Past reports have brought attention to both government and industry-led global initiatives designed to facilitate the integration of sustainability and impact into finance. They include the United Nations Environment Programme Finance Initiative (UNEP FI’s) Principles of Responsible Banking, and the UN-convened Net Zero Asset Owners Alliance committed to transitioning investment portfolios to net-zero Greenhouse Gas (GHG) emissions by 2050. Other relevant initiatives include the World Benchmarking Alliance’s Financial System Benchmark, which will rank the 400 most influential financial institutions on their contribution to achieving the Sustainable Development Goals, and the ISO Technical Committee 322 on Sustainable Finance. Advances in transparency, which bring improvements in accountability and comparability, are essential for sustained change in the sector. But they are not enough to drive behavioural change at the scale and with the required speed.

Values-based banks practice banking with a holistic focus on the real economy to deliver clear societal benefits (environmental regeneration, economic prosperity and social empowerment). They have consistently shown that serving the real economy leads to better and more stable financial returns than those shown by the largest banks in the world. These values-based banks, members of the GABV, operate in numerous markets and serve diverse needs. They use distinct business models to address real banking needs, especially access to credit, of enterprises and individuals within their communities.

Why isn’t all banking done this way?

The business case for values-based banking is compelling. It has contributed to the rise in visibility and relevance of sustainable finance globally and could indicate that the sector has reached a tipping point. Yet, despite the growing realisation of the limits of banking driven by only profit, it is still emerging as a dominant force in the banking sector. Inertia and the power of the status quo, including existing personal incentive structures, piecemeal or fragmented ESG integration, and a lack of courage and innovation by banking executives and shareholders, remain barriers to the pursuit of deep-seated, systemic change.

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