ESG Factors for Banks, Part Two: Governance Factors

This is the second in a series of commentaries discussing the Environmental, Social, and Governance (ESG) factors that could affect the ratings of banks rated by DBRS Morningstar. In this second commentary, DBRS Morningstar discusses the three governance risk factors that DBRS Morningstar considers in the ratings analysis of banks. The negative impact of mismanaged governance usually feeds through banks' profits as a result of penalties, and/or payments for compensation, and/or loss of business.

Key highlights:

o DBRS Morningstar views good governance as a prerequisite to a bank's ratings.
o Although banks are exposed to a number of ESG risk factors, governance risk factors have had the most negative impact on banks' credit profile.
o Governance risk factors tend to relate to intangible items such as culture and accountability and are difficult for external parties to monitor and assess.
o DBRS Morningstar considers three governance risk factors. These are: (i) Bribery, Corruption, and Political Risks; (ii) Business Ethics; and (iii) Corporate Governance
(i) Bribery, Corruption, and Political Risks: Alleged or actual illicit payments can pose a financial or reputational risk to banks. Additionally, political risks can affect a bank's financial position and/or its reputation.
(ii) Business Ethics: General professional ethics can pose a financial or reputational risk to banks. Deficiencies in business ethics would usually result from the lack of a strong risk culture which can be associated with a lack of responsibility, accountability, and/or lack of respect for controls.
(iii) Corporate Governance: Corporate governance failures can negatively affect banks' financial wellbeing or reputation. Most recent examples would be the money laundering failures that many banks continue to face.

"Although banks are exposed to a number of ESG risk factors, governance risk factors have had the most negative impact on banks' credit profile, and a large number of examples have demonstrated that banks can experience damaging reputational issues that are accompanied with a significant financial impact following governance-related issues. In this commentary, we discuss the three governance risk factors that we consider in our ratings analysis of banks." said Vitaline Yeterian, Senior Vice President, Global FIG.