The Concept of Ethical Banking
The concept of ethical or social banking is often associated with microcredit financial activities, typical of developing countries.
However, particularly in the Northern Hemisphere, the concept of ethical or social banking is also applicable to the activities of a range of banking institutions that emerged during the 20th century, which “work for the common good and ensure the right to receive credit through a bank activity consisting in raising funds and reallocating them in the form of credits for cultural, social and environmental projects. Through their activity, ethical banks promote social inclusion, sustainable development, development of social economy and social entrepreneurship” (European Federation of Ethical and Alternative Banks and Financiers).
Although there is no label or standard distinguishing ethical banks from conventional banking alternatives, most of these banks are currently aggregated in the Global Alliance for Banking on Values (“GABV”), an independent network that includes more than 70 members spread across 5 continents.
Activities and Principles of Ethical Banking
Since the creation of the GABV, its members have recognised the need to clearly establish a set of principles that differentiate the activities of ethical banks from those of conventional banks, namely:
1. Triple Bottom Line Approach: At the core of ethical banks’ business model is an approach founded on people, the planet, and prosperity.
2. Real Economy: Focused on the community where they are located, ethical banks serve the “real economy” and foster new businesses that satisfy both the community’s and the economy’s needs in a sustainable way.
3. Transparency and Inclusion: Ethical banks prioritise transparent and inclusive governance models. Transparency is also a fundamental criterion in investment management.
4. Long-Term Robustness: Ethical banks are sustainable organisations, with a long-term vision and strong resilience against external disruptions.
5. Customer Orientation: Establishing lasting relationships with customers and having direct knowledge of their economic activities and associated risks are fundamental characteristics of ethical banking.
The activities of ethical banks are, for the most part, still very traditional, such as deposits and loans, with the majority of funds being used for credit activities.
However, these activities differ from those of traditional banks due to ethical banks’ commitment to the principles described above and to solving social, environmental, and economic problems in a sustainable way.
Additionally, according to FEBEA, an ethical bank should only distribute a maximum of 15% of its regulatory capital and cannot, in any case, grant loans without considering collaterals and security, including social or personal collateral provided by the local networks where the funding is allocated. Their profit is primarily derived from the interest on the loans granted.
Ethical Banking in Portugal
Ethical banking in Portugal is, at present, an option that could offer a decisive advantage for banks wanting to position themselves in the domain of social responsibility and sustainability. The additional principles of social responsibility will be increasingly imposed on financial market players due to their tremendous potential impact on achieving a fairer and more sustainable society.
In the European Union (EU), ethical banks such as the Netherlands-based Triodos Bank, which exclusively finances projects and companies that promote environmental, cultural, and social sustainability, are gaining traction.
It is important to understand the concept of ethical banking holistically, considering that these banks can and should continue to provide traditional banking services. However, ethical banking opens a new range of possibilities regarding the services offered.
There is still much work to be done concerning the regulation and legislation of the ethical banking sector. The legislation applicable to ethical banks in Portugal is essentially the same as that which applies to any banking and financial institution in the country. There is no legislation exclusive to ethical banks; there is, however, a set of regulations and norms that all banks must follow. Nevertheless, ethical banks tend to adhere to additional principles of social responsibility and sustainability that go beyond the minimum legal requirements.
These banks remain subject to the supervision of the Bank of Portugal, which regulates and supervises financial institutions to ensure the stability and efficiency of the Portuguese financial system, and also of the European Banking Authority (EBA) and the European Central Bank (ECB), which regulate and supervise banking activities at the European level.
Directive (EU) 2022/2464 of the European Parliament and of the Council of 14 December 2022 regarding corporate sustainability reporting (“CSRD”) has helped strengthen accountability by imposing transparency requirements. Certain EU companies must now disclose information on what they understand to be the opportunities and risks arising from social and environmental issues, as well as information on the impact of their own activities on people and the environment.
Ethical banking has emerged as a beacon of hope in the quest for a more socially responsible financial system, embodying principles that prioritise human welfare, environmental sustainability, and economic equity. A quintessential example of ethical banking in action is the provision of microcredit, which involves extending small loans to low-income individuals, particularly in developing communities, who lack access to traditional banking services. By empowering entrepreneurs to start or expand their businesses, microcredit not only fosters local economic development but also promotes financial inclusion, lifting families out of poverty and nurturing self-sufficiency.
The regime for microcredit finance companies, set forth in Decree-Law no. 12/2010 of 19 February, establishes that microcredit finance companies can carry out credit operations for small amounts. Although this regime was an innovation, it did not achieve the intended goal, as it was not sufficiently flexible and was not developed in an adequate and complete manner.
Ethical banks often implement strict criteria to ensure that funded projects are environmentally sustainable and socially beneficial, thereby creating a ripple effect of positive change.
This holistic approach to banking underscores the profound impact financial institutions can have when profit motives are aligned with the imperatives of social justice and ecological stewardship. Instead of seeking representation in sustainability and social impact matters, for example, through partnerships with non-profit third sector entities, banks should strive to be their own representatives in these matters – leading policies, adopting a stance of ‘self-regulation’ in this initial phase, and aiming to establish the best guiding criteria for their actions. Banking and financial entities have an unparalleled opportunity here to assert themselves in this market space.
Opportunities and Challenges for Ethical Banks
The growth in ethical banking over recent decades is largely due to its capacity to respond to the demands of consumers who are increasingly looking for financial products that reflect their beliefs on social and environmental issues.
Firstly, ethical banks’ positive impact on society allows them to stand out from their competition, attract a more loyal clientele, and build a more solid reputation than traditional banks.
Secondly, the fact that ethical banks prioritise responsible and sustainable investments contributes to their economic stability and resilience in the long term.
Furthermore, in a rapidly evolving society where the threat of resource depletion demands the adoption of innovative and sustainable solutions, ethical banks’ extensive experience in financing products and services that address social and environmental problems represents another advantage of these institutions.
Yet despite ethical banks representing an interesting alternative for financial innovation centred on people’s needs, their future will face challenges that must be navigated with foresight.
One commonly pointed out challenge relates to their viability, due to their smaller dimension and the market’s perception of ethical banks. While no banking institution is entirely immune to the risk of bankruptcy, this type of bank is more prone to such risk, particularly given the difficulty in achieving a balance between financial performance and social and environmental goals.
Additionally, as the ethical and sustainable alternatives provided by ethical banks have become increasingly popular in society, traditional banks have also started to design products with similar characteristics to ethical banking options, aimed at the same market segment, thus intensifying competition between these two types of banks.
Finally, the subsistence of ethical banks’ initiatives also faces threats of a legal nature. Most ethical banking activities are not framed by any specific legislation and there are no legal incentives or protection mechanisms for these entities. On the contrary, in most countries, ethical banks are regulated by the legislation applicable to the traditional banking system – a reality which hinders and limits their activity.
