'Too Big to Fail' Banks Less Profitable and More Risky Than Sustainability-Focused Banks

Successful banking in the 21st century will focus on these new fundamentals so that those banks following this approach can truly become "too sustainable to fail."
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Co-authored with Tom Bowmer of HIP Investor Inc.

How many banks are "too big to fail"? At least 29, according to the Financial Stability Board. But how many are "too sustainable to fail?" At least 15 banks worldwide in the new Global Alliance for Banking Values (GABV), with assets of $26 billion in assets serving 10 million customers across 20 nations. By loaning capital that ultimately serves core human needs, this sustainable approach to banking can deliver higher returns for bank investors -- and better results for society.

Banks that Focus on Enhancing Society Experiencing Growing Demand

In the aftermath of the financial crisis, the 29 banks defined as "systemically important financial institutions" (SIFIs) by the Financial Stability Board have come under increased scrutiny from citizens, media and customers.

In 2009, Arianna Huffington and Rob Johnson of the Huffington Post called on individuals to move their money out of these "too big to fail" institutions and put it into smaller, local banks that had avoided the excessive risk taking and greedy behavior leading up to the crisis. This soon morphed into a full-fledged "Move Your Money" campaign which aims to empower individuals to reform a broken financial system by putting their money and support behind local and community-based banks. Over the past three years, the campaign says that 4 million-plus accounts have moved from large institutions to their more sustainability-oriented counterparts

Clearly, people have begun to seriously reevaluate their relationships with "too big to fail" institutions, and are starting to take action. The impetus to put your money with a bank that serves the community where it is based and aims to have a positive impact on society is enticing. But does this sustainability banking approach make financial sense?

"Too Big to Fail" Not As Profitable As "Too Sustainable to Fail"?

The Global Alliance for Banking on Values, in its new report, "Strong, Straightforward and Sustainable Banking" concludes that sustainable banking can be more profitable and less risky.
In this groundbreaking and insightful report, "too big to fail" institutions -- which include well-known names like Citigroup (NYSE: C), Goldman Sachs (NYSE: GS), and JP Morgan Chase & Co. (NYSE: JPM) -- between 2007 and 2010, experienced higher risk, were less profitable, and had more leverage than sustainability-minded banks (which include smaller financial institutions from Canada to Germany to the U.S.).

The financial evidence dispels the prevalent, biased notion that it is impossible to "do good" and "make money" at the same time. Banks with a sustainability strategy, seeking both Human Impact and Profit (HIP), outperformed some of the world's largest financial institutions on several important financial metrics. For example, "too sustainable to fail" banks' return on equity averaged just over 7%, while mainstream "too big to fail" banks averaged about 6% over the same time period, which was that high due to being more levered with debt.

"Too sustainable to fail" banks exceeded "too big to fail" traditional banks on several metrics:

•Higher return on assets by 1.33x
•Higher rate of "good quality" capital by 1.5x
•Higher percentage of loaned out assets by 2x

Sustainable Banking Positioned for Stronger Performance

At HIP Investor, our evaluation of 3,000-plus companies globally centers on three main themes, which connect potential financial performance with leader indicators embedded in a sustainable approach.

1) What share of the company's products and services have a positive impact on the customer?

2) How much human, social, and environmental impact is quantifiable?

3) How does the company embed sustainability into everyday decision-making?

A sustainability-oriented banking method focuses on long-term business value that can minimize risk and lead to increased profits.

Sustainable Banking Serves Core Human Needs

"Every banking product and service we provide serves human needs - defined as food, energy, education, housing, health and culture," says Managing Director of GLS Bank Thomas Jorberg. Furthermore, he says, "a study by Adelphi on behalf of the German environment ministry showed that savings deposits of the GLS Bank used for renewable energies were associated with 67% fewer greenhouse gas emissions than an average savings product from German banks."

Across the globe in Asia, most businesses in Bangladesh serve everyday needs of its 160 million citizens, all in the size the state of Wisconsin. BRAC extends access to banking and working capital for small and medium enterprises (SME), with loans as small as $2,500 -- and ends up reaching more than 365,000 businesses, more than 50% of the business for the bank. BRAC Bank has disbursed over U.S. $2 billion worth of SME loans in just 10 years, and is one of the only banks in the country with a report on its human, social and environmental impacts.

Quantifying Positive Impacts of Sustainable Banking

Triodos Bank, based in the Netherlands and operating across 5 European nations, places an emphasis on total transparency in its operations. Triodos publishes online details of all its loans. CEO Peter Blom says "all stakeholders can see exactly how the money entrusted to Triodos is used." This practice creates a high degree of trust between the bank and its providers of capital, and it also contrasts starkly with most of today's large financial institutions.

One PacificCoast Bank, which now includes sustainability-banking pioneer Shore Bank Pacific, not only makes loans to sustainable businesses and housing, it also conducts its operations out of offices that were built using LEED green building standards, lowering the environmental impact and operating cost of its own operations, as well as providing a healthier place for employees to work and customers to visit.

Making Sustainable Decisions Every Day

Sustainable banking requires everyday decisions to consider all factors -- from society to the environment as well as profits. For example, Tamara Vrooman, CEO of Vancity, Canada's largest credit union, says "we do not have a separate sustainability strategy but rather a sustainable business strategy measured by outcomes related to the impact we make." Its progress is measured and published in an accountability report for stakeholders to review every two years.* This Accountability Report itself is externally-verified by a third party and includes targets and action plans designed to improve future performance.

New Resource Bank also incorporates sustainability into its every day decision-making by using a "Client Sustainability Assessment" to rate each of its borrowers. This tool helps it to attract more capital from investors in the bank (which now includes Portfolio 21 mutual fund, PORTX) who see that working capital and loans are going to entrepreneurial, job-creating businesses.

Companies that adopt a culture, process, and system of sustainability, like these "too sustainable to fail" banks, have the potential to generate higher financial performance and reduce risks -- creating a distinct competitive advantage in the marketplace.

Will Traditional Bankers Evolve in the 21st Century?

Triodos CEO Peter Blom explains that the global banking industry "has tremendous potential to affect positive change through its ability to finance entrepreneurs and stimulate local economies." Mainstream banks need to reevaluate their role in the broader financial system and understand who it is that they are serving with their current activities. "Banks that only look at the financials are only getting a part of the story," continues Blom. "The rest is risk, whether it be social, cultural or environmental."

Sustainable banking offers a path towards more compelling examples of innovative products, quantifiable human impact metrics, and decision-making practices, but mainstream banks could also look to their own past for inspiration. A.P. Giannini, one of the founders of Bank of America (NYSE: BAC), provides a powerful illustration of the kind of service that today's institutions could be offering. In 1904, he founded the Bank of Italy in San Francisco "as an institution for the 'little fellows' -- the hardworking immigrants other banks would not serve." Initially, he operated his bank out of a converted saloon, and rumor has it that loans were sealed only with a handshake, not a contract.

Banking can thrive in the 21st century by reflecting on Giannini's history and the recent results of sustainable banking. Institutions that are "too big to fail" can increase their potential profit, reduce their risk, and benefit society by pursuing a richer, deeper strategy of sustainable banking outlined in the Global Alliance report.

In essence, successful banking in the 21st century will focus on these new fundamentals so that those banks following this approach can truly become "too sustainable to fail."

*Editor's note: Vancity no longer produces a separate Accountability Report. As of 2010 it has started issuing an integrated Annual Report. The 2011 Annual Report will be issued on May 8. It can be downloaded here.

R. Paul Herman is CEO and founder of HIP Investor Inc. Herman is the author of "The HIP Investor: Make Bigger Profits by Building a Better World, published by John Wiley & Sons in 2010. Herman is a registered representative of HIP Investor Inc., an investment adviser registered in California, Washington and Illinois, and serving clients in Idaho, New York and Wisconsin.

Tom Bowmer is a Corporate Financial Analyst with HIP Investor Inc., a Phi Beta Kappa fellow from the University of California at Berkeley, and an MBA from San Francisco State University.

NOTE: This is not an offer of securities nor a solicitation. The information presented is for information and education purposes, and does NOT imply any investment recommendations. Past performance is not indicative of future results. All investing risks loss of principal. The author, HIP Investor Inc. and HIP's clients may invest in the securities mentioned above, including in the HIP Portfolios. Details and full disclosures are at www.HIPinvestor.com

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