Should banks be required to lend to all comers? A proposed rule change by the US Office of the Comptroller of the Currency, a banking regulator, to ensure “fair access” to finance would mandate banks to rely solely on financial considerations when lending. Any banks which used environmental, social and governance criteria to refuse loans to, say, oil and gas companies operating in the Arctic, could face penalties. The likes of Goldman Sachs, Bank of America and JPMorgan have all done so.
The OCC’s suggestion follows a similar rule change from the Department of Labor, stipulating that pension funds should not choose investments on behalf of their clients if ESG requirements are placed above returns. This is said to be to protect savers and ensure the funds provide “for the retirement security of American workers” in the words of Secretary of Labor Eugene Scalia. The proposals appear an attempt by the outgoing administration of Donald Trump to hold back the tide of socially-conscious investment.
There is a broader principle behind the OCC’s mooted rule. Businesses are not only under pressure in the US to respond to climate change but banks have been encouraged by different activist groups to curtail lending to gun manufacturers, private prisons or family planning clinics. Increased regulatory transparency and the ease of obtaining information about companies’ activities means that businesses which violate social mores risk a backlash from consumers and their employees. In this atmosphere the desire to ensure companies engaged in legal activities are not discriminated against is understandable.
Ending discrimination in the financial sector has long been a goal of policy. In the US, the Equal Credit Opportunity Act dating from 1974 forbids banks from refusing to lend to people based on race, religion or gender even if there are reasons to believe they are worse financial prospects. In 2012 the EU introduced a rule that said car insurance companies could no longer discriminate in favour of women even though they are statistically less likely to cause an accident.
Companies are not people, however. When lending to businesses, financial institutions are not discriminating based on their identities but on the activities they are involved in — a legitimate reason not to engage in a business relationship. Banks should be entitled to lend, or not, to whichever enterprises they want so long as they are not engaged in illegal activities. There is a difference between banks and pension funds, too. While banks provide a quasi-public utility service, pension funds operate solely on behalf of their clients who also have non-financial interests and may be perfectly happy to give up returns to meet these other needs.
There is no neat separation between ESG and financial concerns. Many investors argue that companies that pay attention to ESG standards do better in the long run; others point to the reputational risk that ethically-questionable companies run or the potential for government regulation — including outside the US — that leaves fossil fuel assets stranded. Lending to oil projects in the Arctic meets President Trump’s approval but his successor will take a different approach.
Either way, the proposed law is unworkable. As the Bank Policy Institute, a financial lobby group, points out, banks have regional and sectoral specialities — a bank in Maine may have little ability to assess the viability of an oil and gas project in Alaska. Mandating banks to invest, rather than keep their powder dry, flies in the face of sensible prudential risk management. Banks should not be forced to make bad decisions.