Global banks are increasingly embedding environmental, social and governance (ESG) factors into their risk-management frameworks, Fitch Ratings says in a new report. More than half the 182 banks that took part in Fitch's ESG survey said they incorporated ESG considerations "always" or "most of the time" into most of their risk-management processes. The exception was asset pricing, where only 39% of banks considered ESG "always" or "most of the time". However, this proportion is likely to increase if governments introduce financial or regulatory incentives to channel funds into more environmentally sound investments.

Policy developments to favour ESG goals could incentivise the transition to a low-carbon economy but financial incentives to prioritise sustainable, or "green", assets over less sustainable assets remain under-developed. The Network for Greening the Financial System, which comprises numerous central banks and financial supervisors, plans to assess whether a risk differential exists between "green" and "non-green" assets. Regulators may find it challenging to determine prudential requirements to incentivise "green" assets without compromising on the need for banks to hold capital commensurate with asset risk.

Our survey, which covered banks in 49 countries, found that ESG emphasis varies by region, with Asia-Pacific and African banks the most likely to take account of ESG in their risk frameworks, and Russian and North American regional banks among the least likely. We expect banks to make greater use of ESG risk data in their risk-management frameworks as the quality of disclosures on corporate sustainability and climate-related risks improves, making it easier to access reliable and comparable data on ESG risks.

Climate change features in risk frameworks at most of the largest banks (those with total assets of more than USD500 billion), although they are still struggling to quantify potential financial impacts from climate change. In contrast, we found that assessment of the effect of demographic changes on portfolios is more common at small and medium-sized banks. This could reflect their proportionately greater exposure to demographic changes given their narrower product range and geographical coverage than large international banks.

Governance is typically the most influential ESG factor in banks' credit ratings, but environmental risk and, to a lesser extent, social risk could play a growing role as governments, financial markets and regulators develop greater focus on them.