Are Corporate Bankers Equipped to Handle Greenwashing Risks?

Greenwashing poses significant risks to banks, which must address both their own and their clients' sustainability claims.

In brief

• Greenwashing is a growing reputational, financial and legal risk for all companies. Greenwashing from corporate clients could become a credit risk to banks.
• Corporate bankers need insight into clients’ greenwashing profiles to improve credit assessments and lower transitional risks.
• Tools, training and routines are key for efficient and effective risk management.

Greenwashing is the practice of presenting products, services, or entire companies as more environmentally friendly than they are. This includes vague language, irrelevant claims, lack of substantiation, or even misleading visuals. Just as greenwashing can take many forms, so can the related risks. With new European regulations, companies are increasingly facing reputational damage, fines, penalties, and litigation. The financial downside to a company can be significant. 

In addition to the direct risk of greenwashing from their own claims, banks also face indirect greenwashing risks from their lending. Financing companies that greenwash can pose a direct credit risk due to the potential financial fallout for these companies. We argue that banks should integrate greenwashing risks in their credit assessment and portfolio management. To do so, corporate bankers need better insights than what is broadly accessible to them today. 

Why Indirect Greenwashing Should Be a Concern for Corporate Banking

While banks are evolving their credit assessments to include ESG risks, most are currently not considering indirect greenwashing risks from clients. However, it is important to understand if the marketed sustainability profile of corporate clients matches their actual efforts and performance. Providing sustainable finance products to companies that are later accused of greenwashing could put the bank at reputational risk. Perhaps more importantly, failure to identify and address greenwashing risks for clients can also lead to credit risk. With fines up to 4% of annual turnover in the EU, the potential financial downside from fines alone is significant. Companies in breach could also have their products or revenue confiscated and face reputational damage.

By creating an illusion of sustainability, greenwashing lowers the pressure toward transitioning. A company might benefit from an unsubstantiated, sustainable profile in the short term, but there will soon be a growing backlog of necessary transitional activities. This drives credit risk in the medium to long term. Various EU directives are addressing this short-term loophole, such as CSRD, SFDR, the Green Claims Directive and the Empowering Consumers Directive. We expect that these regulations will not only lift greenwashing higher on the agenda but also increase the availability and comparability of ESG data. 

Evaluating Indirect Greenwashing Risks

There’s a growing need for deeper due diligence processes that focus on the sustainability claims made by companies. Like anti money laundering, it is not sufficient to claim compliance – the bank should investigate to reduce the risk of being misled. 

Evaluating indirect greenwashing risks is not straight-forward. To avoid greenwashing, companies must be in control of both all existing and new communications where green claims might occur. For larger corporations, the scope will include all online presence, in addition to packaging and other marketing channels. It is a highly resource intensive task to go through all existing communications to identify and evaluate greenwashing risks manually. Additionally, this is not a one-time exercise, but something that needs to be monitored as market practice and regulations evolve.

A manual analysis of a client’s communications is too time consuming for a regular credit assessment and requires a high level of legal and sustainability expertise. Today, it is therefore more common to look for indirect indicators of greenwashing. Companies that have performed a double materiality assessment with external verification, or have a transition plan, may be viewed as lower risk. Unfortunately, while these exercises are important and useful to ensure a robust sustainability strategy, they can also put a company at elevated risk of greenwashing. Without sufficient controls it is difficult to verify if a transition plan describes a credible road to net zero, and whether the company is following up on its decarbonization levers. 

We argue that banks should go deeper in their assessments and profiling of their portfolio companies to be able to effectively mitigate greenwashing risks. With more advanced analysis, banks can mitigate their own indirect risks and accelerate the green transition through increased client engagement and awareness.

Positioning Corporate Bankers to Mitigate Indirect Greenwashing

While banks have different maturity levels when it comes to mitigating greenwashing risks, four key areas might be relevant to ensure a robust anti greenwashing setup for corporate bankers:

1. Include greenwashing in credit risk assessments
   Banks should include greenwashing in their ESG assessment of clients. This especially relevant for sustainable finance products, but a company’s greenwashing risks should be considered a credit risk. Greenwashing can both be considered as part of an initial, light ESG assessment, and as part of a deeper due diligence process. 
2. Enhance Training
   Banks should provide targeted training programs focused on identifying and managing indirect greenwashing risks. These programs should help raise awareness of the importance of monitoring clients’ sustainability practices and commitments. The risks should be understood on all levels, with role-based customization.
3. Ensure Effective Risk Mitigation and Monitoring
   Technology plays a critical role in addressing indirect greenwashing risks efficiently. Similar to AML tools, there are tools that can help building a greenwashing risk profile for clients. An example of this is the EY Sustainability Claims Platform, which allows banks to scan public and unpublished materials to identify potential risks related to their corporate clients. This approach reduces both time spent on manual reviews and the need for specialized legal expertise. Tools like this can also be efficient in following up on clients over time. 
4. Improve Client Engagement on Sustainability
   Banks should not only be reactive but also proactive in helping clients avoid greenwashing. By educating clients about sustainable practices and helping them to meet verifiable environmental goals, banks can foster a more transparent and credible relationship. This builds trust with both clients and the public, further reducing reputational risks. Building this relationship on a client-specific analysis rather than generic advice will be a differentiator in the market.