Sustainable banking has been developing for decades, but it has accelerated rapidly as the financial crisis has taken hold. Why? What makes these apparently unconventional financial institutions more crisis-resistant than their mainstream contemporaries? And can they offer a viable alternative, plotting a path for the future which other banks can follow?
Sustainable banking is becoming a significant force in the world’s financial markets. The ten best known sustainable banks in the developed world have assets of around $30 billion, not including the much wider-reaching, more mainstream institutions like the co-operative banks. These commercially solid, growing banks focus on financing environmental projects, social entrepreneurship and community businesses. Even though they operate in emerging markets, microfinance banks have realized extraordinary growth rates in both volume and profit. The total assets of all microfinance providers are estimated at $50 billion; they serve 150 million people in the developing world.
As the sustainable banking industry has flourished, so have some of the key institutions driving it. Triodos Bank is one. Founded in the Netherlands in 1980, today it has offices in five European countries. Over two decades, the bank has built assets under management of almost $5 billion and grown by 25 per cent per year, delivering a consistent profit. It has almost 10,000 sustainable businesses and projects in its loan book and close to 200,000 customers. Investors, customers and commentators alike are increasingly familiar with this kind of solid growth. Perhaps more surprising, these organizations have been propelled forward by the credit crunch and the turbulence that followed it.
That Triodos has been able to side-step the worst impact of the crisis and prosper despite it, is not a matter of luck. As the core of its banking, Triodos finances sustainable businesses delivering clear social, environmental or cultural benefits. As such, it is directly connected to the real economy, only financing businesses and projects which provide services and products that people need. In essence, Triodos offers basic banking. A decent profit, a strong capital base (15 per cent Bank for International Settlements (BIS)-ratio) and a stable funding base from savers’ deposits are integral parts of our business approach. And we think this straightforward model is the way banking should be.
Investing depositors’ money in packaged and repackaged sub-prime mortgages is precisely the opposite. The issue is not so much the sub-prime mortgage itself. It is the demise of the relationship between bank and homeowner which characterises it, that has led to such catastrophic consequences for the markets and for millions of people connected to them. Banks bundled these mortgages together and sold them to ‘the market’, but the buyer had no idea what to do if the borrowers failed to pay interest or missed their repayments. The relationship between borrower and lender was lost and we are now living through the consequences.
How did we get into this mess?
For many years, basic banking — raising deposits and granting loans — has meant high operational costs and limited profits for banks. Shareholders came to expect ever-increasing returns and substantial management bonuses created incentives for the banks that delivered them. Together, they created a voracious appetite for ever more profitable products and services. This shifted the emphasis of most mainstream banks away from basis banking and the real economy, into potentially lucrative, but more complex and less transparent products. Securitisation of assets became common, creating markets for Collateralised Debt Obligations (CDOs) which created massive profits — as long as a volatile market continued to go up.
This approach led to unprecedented profits — and also to the enormous losses banks face today. Banks like Triodos, which were not prepared to invest in these riskier, complex leveraged financial products, have fared much better. Indeed, at the height of the crisis, Triodos Bank grew its deposit base by 15 per cent in just two months. Many of these new customers are increasingly savvy about what a bank should, and should not do. People who used to be sceptical about smaller banks now understand that staying close to the real economy is safer than being big and involved in global markets for leveraged financial products.
Another factor helped to determine which banks won and lost in the financial crisis: whether or not they are listed on a stock exchange. Triodos Bank deliberately chooses not to be listed, not least because the conventional shareholder relationship is anonymous. Instead, Triodos wants to be close to its shareholders and to explain its long-term strategy. While our shares are not liquid on an exchange, they are issued and can be sold, on a match bargain market which matches buyers with sellers and vice-versa, at regular intervals. And the principle used to calculate their price is based on the value of the underlying businesses we finance, not on the vagaries of market sentiment. The quality of our loan portfolio determines Triodos Bank’s value, not the market. This approach is straightforward, grounded in real companies and the people who run them and prevents speculation.
In contrast, listed banks have to fight the perception of being weak as stock prices drop. And because they have dropped so far, depositors have become anxious, transferring their money quickly via the internet. This left some banks facing systemic problems and needing government intervention to rescue them. These problems have a profound impact on the public, making increased regulation inevitable. Because, if nothing else, the financial crisis made it abundantly clear that the financial markets are not able to regulate themselves.
What does the future hold?
How can we learn from what has happened and change the way we handle our money, so our banks can become solid pillars of our financial system and not the biggest threat to its longer-term health? And is there a role for sustainable banks like Triodos?
The past few calamitous months show that banks are not just ordinary businesses with money as their core product. Money, especially savings, is fundamental to the way we live our lives —just like clean drinking water, electricity, healthcare and education. In this sense, the banks provide a public service, looking after our money when we are not using it and allowing us to send it to each other. But if we do not want to nationalize these core functions, we need bank regulation that is clear and linked to a reliable savings guarantee programme which will protects savers’ money should a bank go under.
The only way to make sure this happens is to separate basic banking from the extraneous financial functions now offered by so many modern mainstream banks. To regulate savings, loans and payment facilities and call the institution that provides them a bank is simple, transparent and makes a depositor’s guarantee scheme affordable. Other functions, like insurance and investment banking need to be kept separate. This should be the first challenge for governments and regulators alike.
What should we expect of our banks?
A solid banking sector is needed to finance solutions to the real problems we face, especially those of climate change and poverty. Worldwide, a significant and growing minority of people want to invest their money in a more sustainable future and need the banks to help them do it. They should respond, not least because they can. Instead of generating artificial profits from complex financial instruments and unacceptable risks, banks are in a unique position to facilitate lasting change.
The paradigm taking over now, whether we like it or not, is that financial capital is no longer the limiting factor for growth and prosperity. We need a new, better balance between the three key elements of production: natural resources, labour and capital. Despite the financial crisis, we are not short of money: we just have to make better use of it.
Banks play a critical role in this process. Sustainable banks, including microfinance banks in emerging economies, have proved that their core business works. They service their customers, helping them to become successful social entrepreneurs and contributing to sustainable development. They are profitable, social innovators in the financial sector. Three important lessons can be learned from their success:
1. Sustainable banks focus on the relationship with their customers. They institutionalise the relationship between the depositor and the borrower, not just with money but by highlighting the interdependence between the two. The result is committed depositors who understand what their bank is using their money for and borrowers who feel supported by it. Equally important, the increasingly controversial reward systems that offer inflated financial bonuses need to be informed by the ‘value’ of relationships, not just transactions.
2. Sustainable banks know their shareholders are not listed. Their relationship with shareholders goes well beyond a financial return. Instead, shareholders and sustainable banks share a common mission. This makes them extremely robust in the face of external shocks - and shocks don’t come much bigger than the current financial crisis. Questions of ownership are critical. Either banks can choose not to be listed, or they can choose to follow clear, strong codes for socially responsible shareholding, so shareholders know exactly what they are letting themselves in for if, and when, they invest.
3. Sustainable banks are about core banking. They focus on the sectors they know well, financing businesses in the real economy. And they provide inclusive financial services in emerging markets for poor but commercially astute people. Their success highlights the need for a regulatory framework that makes sure banks only work in savings, loans and transactions creating capital as a buffer for depositors — the core business from which they came and and know best. If that approach is implemented consistently, the banks will start to make the margins they need to deliver healthy, effective and key banking services.
The frontrunners in this field are all established, solid, profitable and fast-growing banks. Brought together, they could be a powerful force for change.
(c) Peter Blom is CEO & Chairman of the Executive Board of Triodos Bank