Environmental accounting and the banking sector: a framework for measuring environmental-financial risks

Abstract

Environmental issues present the banking sector with a new challenge. Banks can face financial risks from borrowers defaulting on the repayment of their loans because of fines imposed for poor environmental performance. Indeed, current environmental regulations can make banks liable for environmental damage caused by borrowers. Banks, therefore, aim to minimise these risks with the introduction of environmental criteria into their lending decision-making. These criteria are often based on firms' environmental reports, compiled on a voluntary basis. However, the lack of a common reporting baseline may mean that different information is provided by different industries and countries, a fact that prevents banks from estimating the full risk premium of environmentally vulnerable firms in a standardised and comparable format. Thus, this paper aims to propose a new methodology for measuring the environmental risks of firms to meet the requirements of the financial sector. Specifically, this methodology aims to standardise and quantify this information in an effort to reveal both to the banks as well as interested stakeholders the true environmental risk arising from firms' operations.