ESG in banking is the practice of evaluating environmental, social, and governance factors alongside traditional financial metrics when a bank lends, underwrites, invests, or manages other people’s money. Because banks decide where capital goes, those judgments shape climate outcomes, community access to credit, and the stability of the firms they finance. The framework has three pillars, a growing set of measurement standards, and a U.S. legal environment that has shifted sharply in the last two years.
The Three Pillars and What They Cover
Environmental
The environmental pillar covers climate change, pollution, resource use, and biodiversity. A bank’s direct footprint from office buildings and data centers, its Scope 1 and 2 emissions, is small. The larger exposure comes from what it finances. These indirect emissions, called financed emissions or Scope 3, represent the greenhouse gas output of every borrower, project, and company the bank funds. For large banks, financed emissions dwarf operational emissions by orders of magnitude.
Two distinct risks sit inside this pillar. Transition risk is the financial fallout from the shift to a lower-carbon economy: carbon taxes, new regulations, or sudden demand drops that hurt fossil-fuel-dependent borrowers. Physical risk is the tangible damage from extreme weather, which can devalue collateral in flood-prone mortgage portfolios or drought-hit agricultural loans. Both feed into loan-to-value calculations and portfolio diversification at most large institutions.
Social
The social pillar covers a bank’s relationships with employees, customers, and communities. For U.S. banks, financial inclusion sits at the center. The Community Reinvestment Act requires federally regulated banks to help meet the credit needs of the communities where they operate, including low- and moderate-income neighborhoods.1Board of Governors of the Federal Reserve System. Community Reinvestment Act CRA evaluations feed into regulatory decisions on mergers, branches, and other applications.2Office of the Comptroller of the Currency. 12 CFR Part 25 – Community Reinvestment Act and Interstate Deposit Production Regulations
Fair lending law layers on top. The Equal Credit Opportunity Act prohibits creditors from discriminating based on race, color, religion, national origin, sex, marital status, or age, among other protected categories.3The United States Department of Justice. The Equal Credit Opportunity Act The Fair Housing Act adds protections for mortgage lending. Beyond compliance, banks track workforce diversity, pay equity, and hiring practices. Data privacy also falls here: a breach of customer financial data is a reputational and legal problem that regulators, courts, and customers all take seriously.
Governance
Governance covers the internal controls, board structures, and accountability mechanisms that keep a bank honest. Board independence is the starting point: a majority of directors should be free of management ties and material business relationships that could compromise oversight.
Executive compensation is where governance gets practical. More than three-quarters of S&P 500 companies now tie some portion of executive incentive pay to ESG metrics, based on 2024 disclosures. A bank might link bonuses to a financed-emissions reduction target or a community lending commitment. The logic is simple: if pay only rewards short-term profits, executives have no financial reason to manage long-term risks. The pillar also includes anti-corruption controls, whistleblower protections, transparency in financial reporting, and policies on lobbying and insider trading. Governance standards for banks are more rigorous than for most industries because a failure at a major bank can threaten the broader financial system.
How Banks Actually Apply ESG
Credit Underwriting and Lending
ESG integration begins in underwriting. Banks layer climate risk assessment into standard credit analysis, evaluating a commercial borrower’s exposure to physical risk (is the main facility in a flood zone?) and transition risk (how dependent is revenue on carbon-intensive activity?) across the life of the loan. A borrower with heavy fossil-fuel exposure and no credible decarbonization plan may face tighter covenants or a higher rate.
Sustainability-linked loans push this further. The interest rate adjusts based on whether the borrower hits predefined Sustainability Performance Targets. Meet the targets, the rate drops; miss them, it rises. The typical adjustment is modest, often 5 to 15 basis points, but across a large multi-year loan it produces a real incentive. Sustainability-linked loans made up roughly 72% of global sustainable loan volume in 2024.
Banks also maintain exclusion lists that draw hard lines around what they will not finance. Common exclusions include new thermal coal mining projects and certain weapons manufacturing. Internal audit and risk management enforce those lists against a bank’s public commitments.
Capital Markets
In capital markets, banks act as underwriters and advisors on labeled bond issuance. Green Bonds finance environmental projects like renewable energy. Social Bonds fund initiatives such as affordable housing or healthcare access. Sustainability Bonds cover both. Global issuance of sustainable bonds was projected to reach $1 trillion in 2025.
Investment banks structure these deals to align with voluntary guidelines like the International Capital Market Association’s Green Bond Principles, which set standards for use of proceeds, project evaluation, and impact reporting.4International Capital Market Association. Green Bond Principles Voluntary Process Guidelines for Issuing Green Bonds Credible green bonds typically require an external review, often called a Second Party Opinion, to validate the environmental credentials before issuance.
Asset Management
Banks that run mutual funds and ETFs apply ESG screening. Negative screening excludes industries like tobacco or fossil fuels. Positive screening selects the strongest ESG performers within each sector. Impact investing targets specific measurable outcomes such as clean water access or microfinance expansion, alongside financial return.
Asset managers also use proxy voting to press portfolio companies on climate disclosures, board diversity, or governance reforms. A bank managing a large equity fund isn’t a passive holder; it uses voting power and direct engagement to influence company behavior. SEC Rule 14a-8 governs the procedural side of submitting and responding to shareholder proposals.
How ESG Is Measured and Reported
Measurement is where ESG gets hard. Financial accounting has had a century to settle. ESG reporting is still consolidating, and the picture shifted materially in 2024 when the International Sustainability Standards Board began absorbing several predecessor frameworks.
The Main Frameworks
The Global Reporting Initiative is the most widely used standard for broad sustainability reporting across environmental, social, and governance topics, aimed at a wide stakeholder audience.5Global Reporting Initiative. GRI Standards
The Sustainability Accounting Standards Board takes a narrower, investor-focused view, providing industry-specific standards on financially material sustainability risks. For banking, SASB specifies metrics on financial inclusion, business ethics, and the integration of environmental factors into credit risk analysis. SASB is now maintained by the IFRS Foundation under the ISSB umbrella.6IFRS. Understanding SASB Standards
The Task Force on Climate-related Financial Disclosures built a climate-specific framework organized around governance, strategy, risk management, and metrics and targets.7Task Force on Climate-Related Financial Disclosures. Task Force on Climate-Related Financial Disclosures In 2024, the Financial Stability Board transferred TCFD monitoring responsibilities to the ISSB, folding the framework into broader ISSB standards.8IFRS. IFRS Foundation Welcomes Culmination of TCFD Work and Transfer of Monitoring Responsibilities Banks are now transitioning to the ISSB’s IFRS S1 (general sustainability disclosures) and IFRS S2 (climate-related disclosures), effective for reporting periods beginning on or after January 1, 2024.
Financed Emissions
The Partnership for Carbon Accounting Financials provides the dominant global methodology for calculating financed emissions. Under the GHG Protocol, loans and investments fall under Scope 3, Category 15. The core calculation multiplies an attribution factor (the bank’s outstanding loan or investment amount divided by the borrower’s total equity plus debt) by the borrower’s total emissions.9Partnership for Carbon Accounting Financials. The Global GHG Accounting and Reporting Standard for the Financial Industry PCAF covers six asset classes: business loans, project finance, commercial real estate, mortgages, motor vehicle loans, and listed equity and corporate bonds. The standardization lets banks set portfolio-level decarbonization targets and track them over time.
Social and Governance Metrics, and Assurance
Social metrics commonly tracked by banks include board diversity ratios by gender and ethnicity, CRA community development lending volumes (typically reported as dollar commitments to affordable housing or small-business lending in low-income areas), and workforce composition data. Governance metrics often focus on the share of executive compensation tied to ESG performance goals and the independence ratio of the board.
Many large banks pay for third-party assurance of their ESG data, hiring specialized firms to verify the accuracy of emissions and social impact reporting. External verification reduces greenwashing risk and adds credibility. Some banks publish integrated reports combining financial and non-financial performance in a single annual filing.
Ratings Divergence
A persistent problem: the major ESG ratings providers frequently disagree. Academic research has found that ratings from providers like MSCI, Sustainalytics, and Refinitiv can show low or even negative correlations for the same company. Two agencies can look at the same bank and reach opposite conclusions, because each uses different methodologies, weights different factors, and draws on different data sources. A single “high ESG score” says as much about the rater’s methodology as about the company.
The U.S. Regulatory Picture Has Shifted
What looked like a march toward mandatory climate disclosure in 2023 and 2024 has partly reversed in the United States, even as international requirements continue to tighten.
The SEC Climate Rule
In March 2024, the SEC adopted rules requiring public companies, including banks, to disclose climate-related risks and greenhouse gas emissions in registration statements and Form 10-K filings.10U.S. Securities and Exchange Commission. SEC Adopts Rules to Enhance and Standardize Climate-Related Disclosures for Investors The rule would have required disclosure of Scope 1 and 2 emissions and material climate risks affecting strategy and financial condition.11Securities and Exchange Commission. The Enhancement and Standardization of Climate-Related Disclosures for Investors
The rule never took effect. Immediately after adoption, it faced legal challenges, and the SEC stayed it pending litigation. In March 2025, the Commission voted to end its defense of the rule entirely, withdrawing its arguments in court.12U.S. Securities and Exchange Commission. SEC Votes to End Defense of Climate Disclosure Rules There is currently no federal mandatory climate disclosure requirement for U.S. public companies. Many banks continue voluntary disclosure because investors and counterparties still demand the data.
Federal Banking Regulators Pulled Back
In October 2023, the OCC, Federal Reserve, and FDIC jointly issued Principles for Climate-Related Financial Risk Management for large financial institutions. By October 2025, all three agencies had rescinded them. The OCC said the agencies “do not believe principles for the management of climate-related financial risk are necessary” and that such principles “could distract from the management of other potential risks.”13Office of the Comptroller of the Currency. Risk Management – Rescission of Principles for Climate-Related Financial Risk Management for Large Financial Institutions
Regulators still expect banks to maintain risk management processes appropriate to their size and complexity, and to “consider and appropriately address all material risks in their operating environment.”13Office of the Comptroller of the Currency. Risk Management – Rescission of Principles for Climate-Related Financial Risk Management for Large Financial Institutions Climate risk is not gone from supervision; it is no longer treated as a standalone category with dedicated guidance. The Federal Reserve ran a pilot climate scenario analysis with six of the largest U.S. banks in 2023, but the program has not been expanded or repeated.14Board of Governors of the Federal Reserve System. Climate Scenario Analysis Exercise Results
Anti-ESG State Laws
State legislatures have moved in the opposite direction of what many earlier ESG proponents expected. In 2025 alone, 10 states passed 11 anti-ESG bills. The laws vary, but they typically prohibit state entities from doing business with firms that “boycott” fossil fuel companies, restrict ESG or DEI factors in public pension investment decisions, and in some cases bar proxy advisors from making recommendations based on ESG criteria. Banks operating across states face a patchwork: institutional investors in some states demand ESG integration, while state treasurers in others threaten to pull deposits from firms that consider ESG factors at all.
EU Rules Still Reach U.S. Banks
Outside the U.S., mandatory ESG requirements continue to expand. The Sustainable Finance Disclosure Regulation requires financial market participants to disclose how sustainability risks are integrated into investment decisions and to classify financial products by their sustainability ambitions.15European Commission. Sustainability-Related Disclosure in the Financial Services Sector The EU Taxonomy defines which economic activities count as environmentally sustainable, setting a common standard for what qualifies as a “green” investment.16European Commission. EU Taxonomy for Sustainable Activities
U.S. banks with European operations or products sold into the EU must comply, mapping portfolio activities against the Taxonomy’s technical screening criteria. Non-compliance limits a bank’s ability to market funds as “sustainable” in the EU. The result is a practical floor for ESG disclosure that applies regardless of what happens domestically. The Basel Committee on Banking Supervision has separately published 18 principles for managing climate-related financial risks, aimed at national regulators to adopt over time.17Bank for International Settlements. Principles for the Effective Management and Supervision of Climate-Related Financial Risks
Legal Risks: ERISA Fiduciary Duty and Greenwashing
ESG and ERISA
For banks managing retirement plan assets, ESG creates a real legal tension. Under ERISA, plan fiduciaries must decide based on the financial interests of participants. The Department of Labor’s 2022 rule permits fiduciaries to consider ESG factors like climate change as part of a risk-and-return analysis, but bars sacrificing returns to pursue social goals.18U.S. Department of Labor. Final Rule on Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights Non-financial factors can serve as a tiebreaker only when two options are otherwise financially indistinguishable.
That rule is being replaced. The DOL has committed to a new rule expected by mid-2026, and the House passed H.R. 2988 in January 2026, which would codify a strict pecuniary-only standard. If enacted, ERISA fiduciaries could consider ESG factors only when those factors demonstrably affect risk or return. That would narrow the circumstances under which retirement plan managers can incorporate ESG, and raise legal exposure for banks whose asset management arms market ESG-themed retirement products.
Greenwashing Enforcement
Regulators are focused on whether banks and fund managers back up their ESG marketing with substance. The SEC adopted amendments to the Names Rule in September 2023 requiring funds whose names suggest a particular focus, such as “ESG” or “Green,” to align at least 80% of their portfolio holdings with the stated objective. Compliance deadlines were extended into 2025 and 2026 depending on fund size. The rule makes it harder to label a fund ESG when it holds the same securities as a conventional index.
Broker-dealers face separate obligations. Under existing suitability and best-interest standards, firms recommending ESG products need a reasonable basis for believing those products fit the customer. Misrepresenting a fund’s ESG characteristics, or recommending an ESG product without understanding what it holds, exposes the firm to regulatory action.
Where This Leaves Banks
The measurement infrastructure has matured. PCAF gives banks a standardized way to calculate financed emissions, ISSB provides a global disclosure baseline, and sustainability-linked loans put real financial consequences behind ESG targets. The tools are more robust than they were even two years ago.
The political and legal ground is another matter. U.S. federal regulators have retreated from climate-specific guidance, anti-ESG state laws create compliance conflicts, and the SEC’s climate disclosure rule is effectively dead. EU regulations and international standards keep tightening. Banks that operate globally maintain sophisticated ESG programs to satisfy European regulators and institutional investors even as they navigate domestic political headwinds. ESG measurement is increasingly standardized. ESG policy is not.