ESG in Banking: Risks, Opportunities, and the Role of Internal Audit

Banks face intense scrutiny from regulators, investors, and customers, making ESG a critical priority. The impact and management of these issues vary depending on the bank's scale and type, whether local, regional, or multinational, and whether they focus on retail, corporate, or investment banking.

ESG risks in banks stem largely from their core activities. Environmental risks include funding controversial projects like fossil fuel development; social risks involve labor practices and the mis-selling of financial products; and governance risks encompass 'greenwashing' in reporting, excessive executive pay, and the use of complex structures for tax avoidance or regulatory arbitrage.

Regulators are primary drivers of ESG adoption in banking, often implementing stress tests on climate scenarios. Banks also face rigorous ESG reporting requirements, such as ISSB and ESRS standards. A major challenge for banks remains the availability, integrity, and completeness of data necessary for both internal risk management and regulatory compliance.

Internal audit must integrate ESG risks into their risk assessment processes while horizon-scanning for emerging regulatory and stakeholder concerns. Audit departments can leverage existing auditing frameworks—such as testing lending processes, product governance, executive pay, and anti-money laundering controls—to provide assurance on ESG topics. Auditor involvement in data integrity and reporting controls is increasingly vital to ensuring transparency and regulatory compliance.