Special Feature

Bank Lending and Environmental Protection
- Anurag Khanna
, Promoter & CEO, Banknet India

[This paper was earlier published by the Journal of Indian Banker's Association (IBA)]

(1) Assessment of risk

Conventional credit risk assessment in banks takes into consideration financial risks; industry risks and management risks. Fourth parameter of environmental risk will have to be incorporated. The rating on point scale be given on the basis of potential impact on the environment of the technology used type of industry, resettlement issues, occupational health and safety, major hazards, pollution control efforts, etc. However, the company will be required to achieve minimum rating under environmental risk to become eligible for consideration for the loan. Industries with significant environmental impacts, e.g., petrochemical, thermal power, mining, etc., will need to have a detailed EIA of the project.

The environmental risk assessment should also be implemented for the existing large loan portfolio for safeguarding banks' interest from potential environment impact problems. To make the risk assessment realistic, the report of site visit will be analysed. Site inspection report should include review of past and present use of site, the nature of the neighborhood, the company's production process, status of discharge permits, locations and conditions of storage tanks, wells, etc.

Following is the list of polluting industries notified by Ministry of Environment and Forests and needs to be given special attention by the banks:

*Primary metallurgical producing industries, viz., zinc lead, copper, aluminum and steel
* Paper, pulp and newsprint
* pesticide/insecticides
* Refineries
* fertilisers
* Paints
* Dyes
* Leather tanning
* Rayon
* Sodium/Potassium Cyanide
* Basic drugs
* Storage Batteries (lead acid type)
* Acids/alkalies
* Plastics
* Rubber - synthetic
* Cement
* Asbestos
* Fermentation industry
* Electroplating industry

(2) Environmental Audit

The nature of industry, site, process and magnitude of loan shall decide the type of environmental audit to be undertaken. In absence of expertise in the banks, an independent consultant can undertake the audit, the cost to be borne by the borrowers.

Environmental audits will identify past practice, evaluate current regulatory compliance and identify future problem areas.

Environmental audits can also review a company's capital requirements and the cost impact of environmental compliance on the company's balance sheet and cash/fund flow. The cost effect on the project in case of dealing with hazardous materials, clean up, etc., has to be incorporated in the audit.

Industries/companies with high environmental risk rating may be required to submit yearly EA, progress reports and time table on environmental compliance and minimisation of toxic waste through modification of company's industrial processes and waste disposal practice.

(3) Assessment and Analysis of Credit Requirement

Lending and credit officers need to have a good knowledge about environmental matters, legislations, etc. to properly analyse the information gathered by on site inspection and EA. Every bank should incorporate the topics of environmental risk assessment, related legislations, analysis of EA and EIA of the project, pricing for environmental compliance in their regular credit training programmes. Further, on lines of IFC's Environmental Units (EU), every bank should establish an Environmental Cell (EC) as part of their already established consultancy cells at the level of zonal offices/head offices. EC will become the focal point for environment related activity and will provide the required expertise whenever needed

Credit officers will have to incorporate the estimate of cost for dealing with environmental issues in working of the credit requirement of the borrowers. They will have to provide a summary of the information given by onsite inspection. EA, risk assessment, etc., and give their conclusion and recommendations to assist the decision making in the matter.

(4) Documentation Security and Pricing

(i) Documents Terms and conditions can be incorporated into loan documents to minimise banker's risk from past, present and future environmental liability.

(a) "Loan covenants" can be included that the borrower will comply with all central, state and local environment laws; remedy any present or future contamination; immediately notify the bank if they receive any notice of potential environmental violations or enforcement proceeding.

(b) "Arrangement letter" should specify that charges will be borne by borrower for EIA or EA; submission of yearly environment reports; progress reports; insurance, etc.

(c) "Indemnity" from borrowers indemnifying banker from the costs or damages resulting from hazardous waste clean up; damages due to storage, disposal of materials; cost and expenses resulting from the repairs, etc.

(d) "Undertaking" from the borrowers that all conditions relating to any known environmental problems have been disclosed; no previous environment liability, etc., is pending.

(ii) Collateral

The borrower may be asked for additional collateral security against future impairment of the primary collateral and personal guarantees of directors/partners, etc. Further, a provision for a loan "reserve" dedicated to environmental compliance can be agreed upon.

(iii) Costing

All this is going to increase the cost for the bank. The credit rating exercise, which decides the interest rates can incorporate environmental aspect with provision of negative marks based on the risk assessment. This may slightly downgrade the rating and thus, increase the interest earning for the bank.

(5) Loan Management and Follow up

The environmental aspect to be given due importance at the time of annual review/renewal exercise on the basis of reports of EA, fresh reassessment of risk factors, etc. The Reserve Bank of India inspections as well as in-house inspections/audit to check on this aspect too.

Small Scale Industries

The framework outlined above can be implemented in case of large corporate borrowers. The SSI sector is not in a position to bear the additional expenses on account of environment audit, etc. However, the approach has to change and the banks should incorporate some parameters in the assessment of proposals of SSI to promote pollution control. The appraisal to necessarily incorporate comments on -

Environmental pollution status of industry.

Clearance from the appropriate authorities.

Steps undertaken or proposed for disposal of solid, liquid and gaseous wastes, etc.

Banks shall discourage financing of polluting industries or industries, which are functioning in residential areas. In case of small scale industries located in approved industrial estates, setting up of Common Effluent Treatment Plant (CETP) should be financed by the banks at reasonable pricing.

Conclusion Banks are profit making organisations. If they are to be actively involved in assisting the environment protection efforts, they also need certain incentives for the same. One incentive can be to classify the lending of banks to manufacture and purchase of pollution control equipments; R&D activities for pollution control, environment consultancy services under the priority sector lending.

With the liberalisation process there is a spurt in industrial activity and inflow of capital. Attempts need to be made to mitigate the adverse effects on the environment and society. Due to their effective say in the industrial sector, banks can play a major role in the promotion of environment protection efforts.

Thus, by liberally financing the activities encouraging pollution control and restricting flow of finance to Industries which are using polluting technologies and by assisting and monitoring the pollution control by Industries, banks can play a very important role in fostering a linkagebetween economic development and environmental protection.



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