Source: Finance Derivative
By Tony Coleman, CTO, Temenos
ESG (environmental, social, and corporate governance) has become mission-critical for banks, from meeting regulatory obligations to aligning with customer values to win market share.
Many banks have turned to technology to manage their ESG position. But technology is not a panacea. It also presents a risk that banks fall short of their ESG targets.
Technology that greens
Let’s look at the environmental pillar. Run on-premises or in a private datacentre, technology can be a big consumer of carbon. But deployed with the right infrastructure partners, it can enable banks to reduce their carbon footprint. Cloud is the best example of this. Banks that outsource their computing infrastructure to the public cloud hyperscalers can benefit from their economies of scale and energy efficient build principles.
The geographical spread and scale of these datacentres allows for carbon-aware computing, which involves shifting compute to times and places where the carbon intensity of the grid results in lower carbon emissions. One study of Microsoft’s cloud infrastructure concluded its datacentres emit 98% less carbon than traditional enterprise IT sites. These hyperscalers have a focussed mindset and the deep pockets to match. The new Graviton3 processors that AWS is now installing in its public datacentres, which claims to use 60% less energy than the standard X86 models that have been in wide circulation, is an example of the progress that only a hyperscaler can achieve.
The green benefits ‘of the cloud’ are enhanced by software purposefully built to run ‘in the cloud’. Software vendors that are committed to decarbonising their solutions in the build phase pass those wins down the supply chain to banks. For example, the latest version of the Temenos Banking Cloud was built with a 12% improvement in carbon efficiency. How the software operates can have an even more profound benefit for banks. For example, banking software that runs ‘scale-to-zero’ protocols will automatically shut down or scale down availability according to demand for its service. This is one factor that has contributed to a 32% carbon efficiency improvement in the run time of the latest Temenos Banking Cloud release.
Collecting this evidence is not simply an internal tracking exercise. Regulations are reaching a point where publishing data against ESG targets will be legally mandated. In Europe the ECB and the Bank of England have launched climate risk stress tests to assess how prepared banks are for dealing with the shocks from climate risk. Meanwhile, initiatives like the UN-convened Net-Zero Banking Alliance (representing over 40% of global banking assets), the Glasgow Financial Alliance for Net Zero and the Principles for Responsible Banking add to the clamour for banks to evidence their progress. Tracking ‘Scope 3 emissions’, which includes all indirect emissions that are not owned or controlled by the bank, is the next phase. Recognising this, Temenos has developed a carbon emissions calculator, which gives our customers deeper insight into carbon emissions data associated with their consumption of Temenos Banking Cloud services.
The same concept can be extended to a bank’s customers, with carbon calculators and automated offsetting schemes that help people build towards their personal environmental goals. Doing so brings a bank’s green credentials into the public sphere, turning environmental initiatives into commercial opportunity.
(Box-out)
Flowe, a cloud-enabled digital bank built on green principles, launched in June 2020. It is the first bank in Italy to be certified as a B-Corp and has been able to maintain its overall carbon footprint close to zero, saving 90.81% – 96.06% in MTCO2e emissions compared to the on-premise alternative. Within six months of launch, 600,000 mainly young Italians had become customers, at one point onboarding 19 new customers per second. This rapid launch and growth was only possible with the agility and scalability of cloud. Read more about this story.
Technology that reaches
Cloud also enables financial inclusion, a key tenet of ESG ambitions. Today, anyone with a mobile phone and internet connection can access banking services. With elastic scalability and software automation, banks have an almost limitless capacity to serve more customers. And they might not be where you think; 4.5% of US households (approximately 5.9 million) were “unbanked” in 2021. In the past, banks would have seen them as unprofitable targets. But as cloud and the associated automations cut go-to-market and operational costs, the commercial case for inclusion becomes stronger.
Embedded finance gives banks another avenue of reach. Via simple APIs, banks can provide their solutions to non-financial businesses. This ready-made audience might otherwise take years to reach through a bank’s own marketing and sale channels. The embedded finance market is set to be worth $183 billion globally in 2027. That can be seen as a proxy of greater financial inclusion.
AI offers another opportunity to improve financial inclusion. Armed with AI, banks can deliver highly personalised products and experiences for customers. People can be directed to the most appropriate investments, including funds that promote sustainability and loans made with a better understanding of the applicant’s ability to pay it back. ZestAI (previously Zest Finance), a leading provider of AI-powered credit underwriting, claims that banks using its software see a 20%- 30% increase in credit approval rates and a 30-40% reduction in defaults.
But mismanaged, AI can have a dark side. If the data used to train them has bias, systems will perpetuate these discriminations. This can lead to unequal access to financial services and unjust or irresponsible credit decisions. In a study conducted by UC Berkeley, Latin and African-American borrowers were found to pay 7.9 and 3.6 basis points more in interest for home-purchase and refinance mortgages respectively, representing $765 million in extra interest per year. What’s more, AI algorithms are often complex and difficult to understand, so it is hard for customers to challenge decisions and for regulators to enforce compliance.
ESG by design
So how do banks reconcile the ESG benefits of technology with the risks? The answer is in how the technology is built; or more specifically, in the principle of ESG by design.
ESG by design is the concept of incorporating environmental, social, and governance factors into new technology and software features from the outset. The desired outcome is that the solution’s architecture, functions and UX enable ESG optimisation. But it is enabled with a commitment that all decisions taken through the design and build phase are judged through the lens of ESG criteria and targets.
At Temenos, ESG by design is a core principle to how we build technology. Let’s unpick what that means in practice, with some examples.
- Shift-left is how we systematically embed ESG into our banking software services. It means estimating the potential carbon footprint of a new project from the start, and then working back to mitigate it at every stage. The same goes for usability, compliance, and other factors that impact ESG. Detecting and addressing issues earlier in the development process is more effective than taking remedial actions after the event, which risks both compromising the efficacy of the solution and increasing the cost and time of the development lifecycle.
- If there’s a choice to be made, banks should make it. Though ESG goals align with most bank’s commercial aspirations (i.e less carbon equals less cost, more choice and better experiences equals more customers) it is not binary. Banks will have varying appetites of commitment to ESG. Take scale-to-zero, which I referred to earlier. Limiting service availability and adding latency impacts the customer experience and regulatory SLAs, such as payment processing speeds.
The optimum balance is not a call for us, as the technology vendor, to make. Instead we give banks the parameters and configurabilities to make the choice themself. This higher degree of control encourages banks to (a) use carbon-aware computing solutions, and (b) engage with the technology with more purpose.
- Use technology to improve technology. Humans are fallible. AI is only as good as the people that program it. Their biases become the system’s biases. But the black box nature of many AI systems means that these biases go unnoticed. At Temenos we embed an explainable component to our AI tools (XAI). It allows us and our banking clients to understand how AI decisions have been made, and in doing so surfaces flaws that can be fixed. We extend this capability to a bank’s customers, allowing them to interrogate and challenge decisions.
- The complex supply chains in technology makes ESG a collaborative effort. The work we do at Temenos to support banks with their ESG goals would be undermined if our partners didn’t share our same commitment. That means working with hyperscalers and partners in our ecosystem, and opening ourself up to third party validation. We did just that, using an independent carbon calculation platform (GoCodeGreen) to assess our carbon efficiency. I shared the evidence earlier; a 32% carbon efficiency improvement in the run time of the latest Temenos Cloud release, and a 12% improvement in build time. These are the sort of independently verified data points that banks should be asking their technological providers to submit.
Collaboration also means being honest about what others can do better, and enabling their innovations. The Temenos Exchange has almost 120 vendors that are continually extending and improving our core solutions. These include Bud, an AI capability that drives highly personalised experiences for lending and money management; and Greenomy, that makes it easier for banks to capture sustainability data and report on it.
Conclusion
ESG by design is an holistic approach to all tenets of ESG: energy efficiency, financial inclusion, transparency and accountable governance. By working with technology partners that elevate ESG to a core design principle, banks can recognise a wide range of commercial opportunities and ensure compliance with evolving regulations. That should make ESG a core selection criteria of software vendors. Banks will want to find the evidence that their technology partners are as serious about ESG as they are; and that they have the design and build practices that bring these to life.
