Embedding ESG in Banking: Risk, Regulation, and the Road Ahead

Banks are under increasing pressure in 2025 to embed environmental, social, and governance (ESG) principles into their core operations. With over 2,400 ESG-related regulations in place globally, the compliance landscape has become increasingly complex. But this isn’t only about meeting regulatory expectations—it reflects a broader shift in how banks are expected to contribute to sustainable development.

A major change this year is the introduction of the European Union’s Corporate Sustainability Reporting Directive (CSRD), which expands ESG disclosure requirements to large companies and listed SMEs. Unlike earlier voluntary frameworks, the CSRD introduces mandatory, detailed reporting on sustainability-related risks, impacts, and targets. For financial institutions, it raises the standard for transparency and makes ESG a formal part of business reporting.

Banks are now required to report in greater detail on how they identify and manage sustainability risks. These mandatory disclosures go beyond general sustainability narratives, calling for specific information on how environmental and social factors are integrated into risk frameworks. In response, the European Banking Authority (EBA) has issued detailed guidelines to strengthen ESG risk management practices across the sector. These include expectations for governance structures, internal controls, and scenario analysis—raising the bar for how banks evaluate and disclose ESG-related risks.

Climate-related risk has become a central focus of banking regulation and internal risk modeling. Institutions are now expected to evaluate both physical risks—such as the impact of extreme weather events on asset quality—and transition risks tied to the global shift toward a lower-carbon economy. This dual perspective requires banks to build risk models that capture not only current environmental vulnerabilities, but also the long-term financial implications of decarbonization policies and changing market dynamics.

Banks are expanding their risk management frameworks to address ESG-related exposures with the same rigor applied to credit, market, and operational risks. When ESG risks materialize, they can lead to direct financial losses, balance sheet deterioration, and reputational damage. According to KPMG, ESG factors—particularly those linked to environmental regulation, climate events, or social controversies—can impair asset values and weaken a bank’s long-term resilience. As a result, institutions are incorporating environmental and social dimensions more explicitly into their enterprise risk management strategies.

Environmental risk assessments in banking now extend well beyond direct emissions or operational footprints. A growing focus is being placed on financed emissions—classified as Scope 3—which often account for the largest share of a bank’s overall environmental impact. These emissions arise from lending and investment activities and are more difficult to quantify. In response, banks are adopting new tools to improve emissions tracking, scenario analysis, and portfolio alignment with net-zero targets, as highlighted in London Stock Exchange Group’s analysis of Scope 3 for financials.

Social risk has become an increasingly important component of ESG frameworks in banking. Institutions are now expected to assess factors such as labor practices, human rights issues, and community impacts within their lending and investment portfolios. This heightened focus is driven by growing stakeholder scrutiny over the broader social consequences of financial activities. As a result, many banks are incorporating social risk indicators into their due diligence, lending criteria, and broader ESG reporting processes.

A 2024 study by Oliver Wyman highlights that banks with well-integrated ESG risk management frameworks are better positioned to navigate regulatory complexities and mitigate greenwashing risks. The study emphasizes the need for compliance departments to take a proactive role in sustainability initiatives, ensuring that environmental commitments are substantiated and aligned with evolving regulations. This approach not only enhances resilience during market volatility but also strengthens stakeholder trust.​

Banks are increasingly expected to demonstrate measurable outcomes from their ESG initiatives, not just meet regulatory thresholds. To this end, many have introduced tools and metrics to quantify their environmental impact—such as reductions in financed emissions, growth in green lending portfolios, and support for renewable energy projects. These metrics are also being used to track progress toward long-term climate goals, including portfolio alignment with net-zero pathways.

Social performance metrics are also becoming more refined. Banks now assess their contribution to financial inclusion, affordable housing, and access to credit for underserved segments, particularly SMEs. Many institutions also track the broader economic impact of their financing—such as job creation or community development outcomes—offering a more complete view of how ESG efforts translate into real-world benefits.

Governance reforms are reinforcing ESG integration at the institutional level. Leading banks are linking executive compensation to sustainability targets, improving board diversity, and enhancing disclosure practices. There is also growing emphasis on structured stakeholder engagement, reflecting a broader understanding that effective governance includes responsiveness to social and environmental priorities—not just financial performance.

According to KPMG's 2025 ESG Risk Survey for Banks, many institutions continue to face challenges with inconsistent data collection and the absence of standardized ESG metrics. The limited availability of historical data and the complexity of measuring Scope 3 emissions remain key obstacles to integrating ESG into core risk management frameworks. These limitations continue to hinder the depth and reliability of ESG disclosures across the banking sector.

Technology continues to play a central role in supporting ESG integration. Banks are adopting artificial intelligence and machine learning to improve ESG risk modeling, while blockchain is being explored as a means of enhancing transparency in sustainable finance transactions. Big data tools are also helping institutions measure environmental and social outcomes more accurately, and digital platforms are streamlining ESG reporting workflows.

Strong ESG performance is becoming a competitive differentiator. Banks that lead in sustainable finance often benefit from enhanced brand reputation, better access to capital, and closer alignment with stakeholder expectations. These institutions are also finding growth opportunities in emerging sectors linked to climate resilience, renewable energy, and social development—demonstrating that ESG alignment can support both financial and strategic objectives.

In the coming years, several trends are expected to shape the evolution of ESG in banking. These include continued regulatory convergence, deeper integration of technology—particularly in ESG data and risk modeling—and a broader focus that extends beyond climate to include biodiversity, supply chain transparency, and social equity. Stakeholder expectations will also continue to influence strategic decision-making, embedding ESG considerations more firmly into boardroom agendas.

For banks, this shift is no longer about checking compliance boxes. It reflects a structural realignment of the industry’s role in society. Delivering on ESG commitments will require a combination of strong governance, credible metrics, and sustained investment in systems and talent. Those that rise to the challenge stand to gain long-term resilience and relevance.

In this context, the boundary between financial performance and sustainable impact is narrowing. Institutions that integrate ESG into their core strategy will not only strengthen risk management and regulatory alignment—they will also play a central role in financing a more inclusive and sustainable global economy.

As ESG expectations rise, so too does the opportunity for banks to lead—not just in financial performance, but in delivering long-term value for society and the planet.