The latest IMF Global Financial Stability Report discusses the link between sustainable finance and financial stability and suggests policies for the way forward.
Sustainable finance incorporates environmental, social, and governance (ESG) principles into business decisions and investment strategies. It covers many issues from climate change and pollution to labor practices, consumer privacy, and corporate competitive behavior. Efforts to incorporate these kinds of considerations in finance started 30 years ago but accelerated only in recent years.
Environmental, social, and governance issues can have a material impact on firms’ performance and on the stability of the financial system more broadly. Governance failures at banks and corporations contributed to the Asian and the global financial crises. Social risks, for example in the case of inequality, may tempt policymakers to unduly facilitate household borrowing for consumption and could lead to financial instability over the medium-term. Environmental catastrophes have caused large losses to firms and insurers.
Corporations don’t report on sustainability regularly or consistently, particularly with respect to the environmental and social dimensions. This makes it difficult for investors to incorporate ESG principles to their portfolios. Third party providers of ESG scores aim to provide standardized assessments, but sometimes it’s difficult for them to arrive at an accurate picture given a lack of information.
There is also uncertainty with measuring the impact of ESG activities in achieving goals such as reducing emissions or raising labor standards. Greenwashing—false claims of ESG compliance of assets and funds—is also a concern that may give rise to reputational risks. Mixed evidence on the performance and impact of ESG funds makes it challenging for investors, especially public sector pension funds, to incorporate these principles in their investments. Firms face challenges as well: although they stand to benefit from integrating ESG factors in their business models, the positive outcomes are usually long term, but the high costs of disclosure are immediate.
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Full IMF Global Financial Stability Report
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