There are a number of laws that contain provisions regarding conservation of environment,

 

improvement of standards and control of environmental pollution from various sources. Of these, the Bangladesh Environmental Conservation Act (ECA) 1995 is the umbrella Act. This Act established the Department of Environment (DOE), and empowers its Director General to take measures as he considers necessary about environmental pollution. To make operational the ECA 1995 and in exercise of the power conferred under it, the Environment Conservation Rules (ECR) 1997 were issued by the Government of Bangladesh. Together – ECA 1995 and ECR 1997 – provide the framework of environmental regulations relevant to industries.

 

For the purpose of issuing the Environmental Clearance Certificate, the industrial unit and projects shall in consideration of their location and impact on the environment be classified into the following 4 categories: (i) Green, (ii) Orange-A, (iii) Orange-B and (iv) Red. This categorization indicate that green is least polluting and red is most polluting, with the two orange categories regarded as having medium-scale impacts. In its Schedule I, ECR 1997 includes a list of 22 industrial units or projects under Green, 26 types under Orange A, 69 types under Orange B and 69 types under Red. For the each category of industries, there are different levels of documents to be provided at the time of seeking the Environmental Clearance Certificate.   Bangladesh bank issued Environmental Risk Management (ERM) guidelines for Banks/FIs in January 2011.

 

Definition:

 

Environmental risk is a facilitating element of credit risk arising from environmental issues. These can be due to environmental impacts caused by and / or due to the prevailing environmental conditions. These increase risks as they bring an element of uncertainty or possibility of loss in the context of a financing transaction.

 

Sources of Risks:

 

(1) Land location:

 

Borrowers may plan and / or operate on land that is prone to environmental impacts by virtue of its geographical location. Activities on land in the flood plain or along the coastal belt are more vulnerable, and are a source of risk. Being located in a highly polluted area enhances the possibility of closure of all activities. Being located in a declared (though degraded) forest area, which is an eco-sensitive area, makes it vulnerable. Closure of such activities is possible when enforcement is tightened.

 

(2) Regulatory non-compliance:

 

Borrowers may plan and / or operate without technologies (e.g. effluent treatment plants) or management systems that will ensure compliance to the prevailing environmental laws. In such a situation, the borrowers are vulnerable to closure or shutting operations by the Department of Environment (DOE) due to enforcement of environmental compliance.

 

(3) Labour / social risks:

 

The borrower has to provide a safe and healthy working environment for its labour / employees. If it does not, then there is potential for accidents, injury and death and also exposure to occupational health issues. These issues include child labour, forced labour, discrimination, disciplinary practices, working hours and wage compensation. All of these issues can lead to closures and hence can lead to NPL.

 

(4) Community / public opposition:

 

Borrowers may have inadequate environmental management practices in their operations. This can lead to excessive water abstraction, effluent releases, emissions and improper waste management that affect community living in the vicinity of the borrower’s premises. Community protests and public opposition can cause risks.

 

(5) Changing export market conditions:

 

Borrowers, who are exporters, have to meet importing country’s environmental requirements. Some importing country’s requirements are stringent and are also constantly tightened with time. Borrowers who do not upgrade their operating practices to meet these stringent and tightened requirements are exposed to the likelihood of their export contracts being cancelled. The changing requirements can lead to the closure of the borrower’s export contracts and hence not in a position to repay the Banks/FIs.

 

(6) Climate change impacts:

 

Bangladesh is already experiencing climate-induced extreme weather events, e.g. cyclones, floods and droughts, periodically. Due to climate change, these are expected to be more intense and more frequent. Borrowers whose operations are vulnerable to extreme weather events are likely to be affected. Climate change impacts can lead to the borrower not being able to continue the business activity and hence unable to service / repay the financing taken from the Banks/FIs.

 

Types of Risks:

 

(1) Direct Risk:

 

This risk can occur when a Bank/FI exercises operational control over a borrower’s business or in some cases where a Bank/FI takes possession of contaminated land held as security. In such cases, the Bank/FI may not only lose its original advance, but may also be forced to meet substantial clean-up costs.

 

(2) Indirect Risk:

 

As Bangladesh strengthens enforcement of environmental regulations and public interest groups grow, pressure increases on business to minimize their environmental impacts. This may increase companies’ capital and operating costs in order to comply with environmental regulations. This can have an effect on the borrower’s cash flow and consequently in the borrower’s ability to repay. Alternatively, climate change induced events, e.g. cyclones, may impact business activities that may result in affecting the borrower’s ability to repay.

 

(3) Reputation Risk:

 

Not considering environmental impacts arising from a borrower’s operations can result in negative publicity for both the borrower and the Bank/FI. The Bank/FI’s reputation can be damaged if there is a failure of the business activity due to environmental reasons. The Bank/FI will be seen as engaging in irresponsible business practices that do not adequately address the environmental issues.

 

(4) Business / industry Risk:

 

Changing environmental conditions and/or requirements may impact the borrower’s capacity to meet the obligation to repay. This is an indirect risk.

 

(5) Management Risk:

 

Poor management may result in closures and community protests that can adversely impact the business and the borrower’s capacity to repay. This is an indirect risk.

 

(6) Security / collateral Risk:

 

Risk that the Bank/FI might be exposed due to poor quality of the security/collateral, e.g. contaminated land or disposal of hazardous chemicals, in case of a default. This is a direct risk.

 

(7) Legal Risk:

 

This risk can take a number of different forms. Most obviously, banks are at risk if they do not comply with relevant environmental legislation. More specifically, they are at risk of lender liability for clean-up costs or claims for damages if they take possession of property that contaminates or pollutes, as a result of realizing security. This is a direct risk.

 

Stages:

 

There are different stages in Environmental Risk Management as applied to financing transactions: (1) Identifying, (2) Evaluating / Rating, (3) Mitigating and (4) Monitoring & Controlling.

 

Integrating with Credit Risk Management:

 

As environmental risk is a facilitating element of credit risk, Banks/FIs should integrate Environmental Risk Management with credit risk management in all aspects. No separate Environmental Risk Management systems are required. Banks/FIs need to integrate Environmental Risk Management into their credit risk management process. When presenting the credit risk rating of the proposal for financing, the EnvRR should also be provided.   These Guidelines should necessarily be used for all individual customers (corporate, institutional, personal, small and medium enterprise) whose aggregate facilities are above the following financing thresholds:

 

• For Small and Medium Enterprises (SMEs), financing > BDT 2.5 million
• For Corporate, financing > BDT 10 million. and
• For real estate financing > BDT 10 million.

 

These Guidelines should be used for both financing required for new, green field projects as well as those pertaining to existing facilities, e.g. renovation and expansion.

 

Benefits:

 

The following are the benefits that Banks/FIs will derive from adopting these Guidelines:

• Awareness on environmental issues within the staff of Banks/FIs will grow substantively.
• Ability and capacity to address environmental risks in a structured and systematic manner will be established. And, this will lead to reducing NPLs arising directly or indirectly due to environmental issues.
• Borrowers will be encouraged to adopt better management practices that will lead to an overall better environmental performance and preparedness for climate change induced events. This will be a particularly useful contribution in the context of the country’s deteriorating environmental conditions and its particular vulnerability to climate change.
• Last but not the least, these Guidelines will help Banks/FIs demonstrate to the Bangladesh Bank, a higher commitment to addressing environmental issues and a focus on the environmental / sustainability sector.

 

Credit Risk Management function:

 

The responsibilities of this function are (i) to be aware of environmental issues confronting the various sectors, (ii) to review the completed due-diligence checklist and the EnvRR, (iii) to integrate environmental risk considerations into the credit risk assessment and (iv) to specify financing conditions /covenants, if any, are required.

 

1. The Environmental Due-Diligence (EDD) checklist and the Environmental Risk Rating (EnvRR) are to be completed prior to forwarding the proposed financing to the credit risk management for consideration.
2. In this credit risk management function, it is required to verify whether the EnvRR has been correctly done. If not, the Relationship Banking function should be asked to redo the EDD checklist.
3. Wherever the EnvRR is “High”, the credit approval decision should be taken by the Executive Committee / Board. For all other ratings of the EnvRR, there is no separate requirement for approval decision.
4. Wherever the EnvRR is “High”, the credit risk management function will ensure that additional conditions / covenants are included. (examples are given in the guideline on page 22)

 

Credit Administration function:

 

The Environmental Risk Management responsibility of this function is to ensure that additional financing conditions / covenants, if any (e.g. obtaining environmental clearance certificate) in the financing agreements are met prior to initiating disbursement.

 

Credit Monitoring function:

 

This function is to ensure that environmental risk monitoring should also be undertaken as a part of monitoring credit risks.

 

Portfolio Management of Banks:

 

At a portfolio level, Banks/FIs should classify their financing of business activities across the Department of Environment (DOE)’s Categories of Red, Orange A, Orange B and Green (Schedule 1 of the ECR 1997). Banks/FIs should estimate the number and financial exposure to each of these categories. In addition, Banks/FIs should classify their financing of business activities based on their environmental risks, i.e.   “High”, “Moderate” or “Low” and estimate the number and financial exposure to each.

 

Procedure:

 

• Determining the EnvRR:

 

1. On receiving the proposal for financing, Banks/FIs should conduct a preliminary environmental risk review using Environmental Due Diligence (EDD) checklists. There is 01 General EDD checklist (enclosed herewith), 10 Sector EDD checklists and a Guidance Matrix (enclosed herewith). Potential borrowers will have to submit various documents to the DOE for obtaining the Environmental Clearance Certificate. Banks/FIs need to obtain copies of these documents as the background for completing the EDD checklists. However, discussions with the potential borrower should form the basis for administering the EDD checklists.
2. General EDD checklist will be used for determining the Environmental Risk Rating (EnvRR) of the proposal for financing. It include the possible sources of risks – legal compliance or compliance to environmental laws, appropriateness of land for the intended purpose, climate change impacts if any – and also the management systems of the potential borrower to manage these risks. To determine whether these will become environmental risks, the General EDD checklist should be used.
3. Proposals for financing in different sectors are prone to different kind of environmental risks. Sector EDD checklists should additionally be used if the proposal for financing is in any of the 10 sectors. Administering of the Sector EDD checklist concludes with determining the overall EnvRR of the proposal for financing. This overall EnvRR combines both the outcomes of the General and Sector-specific EDD checklists and should be applied as per the table below:

 

General EDD Sector	Sector specific EDD
Low	Low	Low
Moderate/Low	Low/Moderate	Moderate
If any one or both the General and Sector-specific EDD checklists is indicated as “High”		High

 

Sector specific EDD checklist: (total 13 nos.)

 

SL#	Sector	Legal classification as per ECR 1997
1.	Poultry and Dairy	(i) Poultry: This is Orange A category up to 250 birds in urban areas and up to 1000 in rural areas. And, this is Orange B category for above 250 birds in urban area and above 1000 in rural areas. (ii) Dairy: This is Orange A category for 10 cattle or below in urban areas and 25 or below in rural areas. And, this is Orange B category for above 10 in urban areas and above 25 numbers in rural areas. And, for dairy processing, this is Orange B category.
2.	Cement	This is Red category
3.	Chemicals (Fertilizers, Pesticides, Pharmaceuticals)	(i) Fertilizers: This is Red category. (ii) Pesticides: This is Red category. (iii) Pharmaceuticals: This is Orange B category.
4.	Engineering & basic metal	This is Orange B category for engineering works up to Tk.10,00,000 and re-rolling. And, this is Red category for engineering works above Tk.10,00,000.
5.	Housing	This is not classified
6.	Pulp & paper	This is Red category
7.	Sugar & distilleries	This is Red category
8.	Tannery	This is Red category
9.	Textile and apparels	This is Orange B category  (checklist enclosed herewith)
10.	Ship breaking	This is Orange B category

 

• Deciding next steps based on EnvRR:

 

Based on administering the General EDD checklist and the sector-specific EDD checklist, if applicable, the EnvRR for the proposal for financing is known.   The following three possibilities need to be ensured:

 

• If the EnvRR is high, then the proposal for financing will have to be approved by the Board or its Executive Committee.
• If the EnvRR is low or moderate, then the financing decision can be undertaken on the basis of the usual credit risk management guidelines.
• If the EnvRR is unclear, then it is required for the Bank/FI to collect more information from the borrower so as to gain an understanding of the inherent risks and arrive at a high/moderate/low decision. Should a risk factor not be applicable, it may be excluded from the total number of questions used in calculating.

 

Financing Red Category industry:

 

The detailed environmental risk review will be required for all business activities, which are identified in the Red Category under the ECR 1997 being implemented by the DOE. Banks/FIs should engage external consultants to do a detailed Environmental Risk Review on the basis of the Environmental Impact Assessment and associated environmental management plans prepared. Based on this detailed review, the external consultant should advise whether the overall EnvRR will be “High”, “Moderate” or “Low”.