Banks are playing a key role for organizations in transition - Offering long-term added value and going beyond their role as a simple finance provider
German companies are facing a multitude of challenges as a result of the war in Ukraine and continuing constraints on global supply chains. A number of the pillars supporting Germany's export-dependent economic position that were previously taken for granted—such as cheap, readily available raw materials, national security or the globalised division of labour—have just been thrown into disarray.
No ”business as usual”
At the same time, the war and the coronavirus pandemic are accelerating developments that already began several years ago, including the transition to sustainable energy and transport, digitalisation, cybersecurity and shifts in global political and economic equilibria. Even fundamental assumptions such as the benefits of limitless global economic growth and individual mobility are now being questioned. In short, there has been talk of a changing world for a long time, but developments are quickly gaining momentum once again.
Given this acceleration, "business as usual" will not be an option for German companies — instead they will need to their adapt business models to this changing environment increasingly rapidly. This is the only way that companies will be able to be economically successful in the long term while meeting society's changing expectations. There is much to suggest that the German economy will be successful in tackling this mammoth task of transition, but huge efforts will be required from all parties involved in order to achieve this, including the companies, policymakers and, not least, banks, which will largely finance the transition.
It should come as no surprise that far-reaching changes such as these are putting on the pressure to invest, meaning that banks are playing a key role in transitioning to sustainable business models, especially when it comes to financing strategic changes. Many companies maintain trusting long-term relationships with their core banks. But to be able to perform this role on this extraordinary journey in an ever-faster-moving world, banks need to understand the profound industry-specific trends and know how to support companies with appropriate financing services, i.e. they need to have the right industry expertise.
Transition in the interests of banks
From the banking sector's perspective, there are many reasons to encourage companies to transition and actively support this process. One reason is banks' own role within society. This transition is one of the most complex challenges in history, one that will give banks the opportunity to play a key role and restore their position at the heart of society. Banks must therefore take an active role and help companies—and consequently society—to make these necessary changes, for example by helping customers to improve their carbon footprint.
In addition to meeting society's expectations, there are economic reasons for supporting companies during the transition. The demand for specifically tailored financing solutions is constantly growing, allowing banks to establish themselves as strategic partners — provided they can offer the relevant industry expertise. Ultimately, this benefits not only customers, who receive a financing solution that is specifically tailored to their needs, but also banks, which use their expertise to gain a competitive advantage.
Example: fiber optic rollout
One example is fibre-optic expansion in Europe: ING has been involved in four out of the last five projects, providing over €1 billion of funding. In terms of sustainability, the transition has now reached the point where "green" financing is becoming the new standard in the medium term, while "brown" business models will eventually be driven out due to social or regulatory reasons. In this case, banks providing finance risk their reputation as well as facing increased risks of default. Ultimately, banks preserve the value of a company when they drive change in business models together with its customers.
At the same time, the energy transition highlights the importance of working closely with policymakers and regulators. For example, gas-fired power stations are likely to become stranded assets in the long term, meaning that financing them would not be worthwhile for banks. But gas-fired power stations will continue to be necessary during the transition, for the next 15 to potentially even 25 years, in order to safeguard the energy supply. So how should financing be dealt with in this situation? Current regulatory guidelines, such as those in the EU taxonomy, do not adequately reflect the aspect of company transition and instead focus too narrowly on the assessment criterion of achieving a sustainable status quo. Supporting companies with their transition can be done in a multitude of ways. Numerous sustainability funding tools have emerged in recent years:
Green bonds and green loans enable targeted financing of defined green projects and are now considered some of the standard instruments for sustainability-focused funding. In 2021, a total of €65.37 billion was issued for green bonds in Germany. By linking the green bond or green loan with concrete funding projects, the impact achieved can be effectively measured.
Focus on specific objectives
ESG- or sustainability-linked loans, by contrast, begin at a corporate level, as the terms of the loan are improved if the company achieves certain sustainability goals or ratings, or made less attractive if the company falls short of them. This places focus on the overall quality of the company, an aspect that is likely to affect more decisions in the future than just defining loan terms.
Placing greater focus on ESG objectives can be worthwhile for companies in other areas too, such as in the case of financial market instruments. For instance, in May ING launched a pilot project in Germany whereby pricing in foreign exchange trading no longer depends exclusively on the customer's creditworthiness or profitability ratios, but also on their ESG performance. Efforts to increase focus on ESG objectives are therefore incentivised through concrete financial benefits.
In-depth expertise is important
Assessing a company's transition projects and agenda—whether in terms of digitalisation, renewable energy systems or new mobility concepts—requires banks today to have new, more extensive expertise compared to that in conventional lending. Furthermore, changes to business models often go hand in hand with new accounting models. An example in the case of transitioning to sustainable transportation is sharing models such as car sharing and the use of electric charging infrastructure, as the "pay per use" concept causes cash flows to vary and be strongly tied to usage. This means that predicting future cash flows, and consequently assessing corresponding financing plans, is considerably more complex than with conventional machine financing over fixed periods.
As a result, there is increasing demand for interdisciplinary teams in which corporate customer advisors, risk experts, sustainability experts and engineers all work together. Interdisciplinary teams can help to align the wide-ranging interests that stem from the cross-industry interplay of different stakeholders such as producers, operators and users. This setup enables banks to evolve into consulting partners, thereby offering customers long-term added value and going beyond their role as a simple finance provider.
Featured article by Eddy Henning, Member of the Management Board of ING Germany, responsible for Wholesale Banking, 25.06.20212, Börsen-Zeitung