This article was written by University of Waterloo student Erin Murray on sustainable finance & the Sustainable Finance Cycle.
Sustainable finance has been a recent buzzword running through the sustainability community in the last decade but what does it really mean? To fully grasp what sustainable finance is, we must first understand a few key definitions of finance, business finance, and sustainable development.
Finance can be understood as a system that includes the circulation of money, granting of credit, making investments and the provisioning of banking facilities.
Business Finance is broken into two distinct areas:
- Corporate finance looks to maximize corporate value while also managing the firm’s financial risk
- Banking & financial services can be defined as accepting deposits, conducting payment services, asset transformation & risk management
Sustainable Development as defined by the World Commission on Environment and Development’s 1987 Brundtland report Our Common Future is “development that meets the needs of the present without compromising the ability of future generations to meet their own needs.”
Now that we have a more concrete understanding of the components of sustainable finance, we can work to understand what sustainability has to do with finance. The sustainable finance map below helps to display key actors of clients, banks and financial institutions with corresponding concepts of investments, sustainable development, and sustainability risks.
With these concepts and actors in mind we can better understand this concept by defining sustainable finance in two unique categories:
- Market-based instruments such as a carbon tax can be used to deliver environmental and social quality and can be used to transfer sustainability risks.
- Generation analysis and the use of monetized sustainability-related information can be used to improve corporate sustainability performance and economic performance.
According to Sustainable Banking: Managing the Social and Environmental Impact of Financial Institutions, a book penned by two University of Waterloo professors, global sustainable development is closely linked to finance, as banks and financial institutions play a significant role in financing sustainable development and meeting social needs. While historically, sustainable development is discussed under the branch of ecological economics, environmental economics hopes to apply ecological concepts to economics. It does so by internalizing environmental impacts and services in order to place value on the environment in economic terms.
Referring back to the Sustainable Finance Cycle, financial institutions have the capabilities to address sustainability risks, for example, they could finance projects related to climate mitigation and support the shift of traditional fossil fuels to renewable energy. Historically, financial institutions have been critiqued for financing projects that lead to significant environmental risk or damage. By investing of financing ‘greener’ projects they can aid in supporting sustainable development and avoid financial risks. They can also lead a switch away from basic commodities, such as water and food, being subject to financial speculation.
The traditional economic growth model negates sustainability and environmental constraints. Now is the time for banks and financial institutions must strategically plan for the future and value creation must diversify to include environmental concerns. Sustainable finance has the opportunity to support many facets of sustainable development and challenge the historic growth model.
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