ESG and Credit: Serving the Underserved--A Structured Credit Perspective

This commentary discusses the potential social factors of lending to underserved borrowers in the financial industry and how these could affect Morningstar DBRS's structured finance credit analysis.

Key highlights include:
-- A look at different borrowing options available to underserved borrowers in the small and medium-size enterprise sector.
-- An overview of different government initiatives worldwide aimed at supporting lending to underserved borrowers.
-- Whether lending to underserved borrowers could be considered a social factor when it comes to assessing environmental, social, and governance (ESG) factors in the credit analysis.
-- Operational risks when it comes to lending to the underserved.

"Lending to underserved borrowers is an inherently riskier practice. If all claimed lending to underserved borrowers was determined to be an ESG factor in itself, for most structured credit transactions, this would be considered a credit-negative Social factor", said Simon Murphy, Vice President of Operational Risk at Morningstar DBRS. "This is because such lending is often associated with low income/high variability in cash flows, limited-to-no credit/income track record, and high interest rates. Likewise, originators of new loan products to underserved borrowers likely will not have much historical performance data. In certain cases, lending to underserved borrowers can also raise questions in relation to mis-selling, regulatory risk, and compliance risk, all of which are part of our ESG criteria."