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By Dan DormanESG Senior Research Analyst, Calvert Research and Management

Washington - The financial services sector is working through what Calvert Research and Management (Calvert) believes will be a series of waves of stress. This spring, weakness in several regional banks was driven by unique funding challenges and poor asset-liability management decisions at certain institutions. We expect regulatory pressures will remain, with proposed updates to capital requirements for some banks. Finally, questions around asset quality and credit losses will persist as rates remain elevated and monetary conditions remain tight. All these will weigh on bank margins and performance in the coming periods.

How Calvert assesses financial services

Across all financial services businesses, Calvert places great emphasis on corporate governance as well as human capital. We also look at a firm's approach to data security - particularly how well it secures and protects clients' private financial information - and its track record in these areas. For the largest and most systemically important institutions, we assess balance sheet health and the strength of policies and processes to manage systemic risk.

Exposure to climate change-related risks are a factor for certain firms, but we don't simply look at a firm's nominal level of lending or financing to businesses that are energy- or carbon- intensive as a standalone assessment. We are more focused on the effort and intentionality behind developing risk management processes and how climate risk is assessed at the enterprise level. We see a clear differentiation in the marketplace between firms that do this well and those that are behind.

Accounting for macroeconomic issues

Our research process is designed to provide insight into the structural soundness of financial services companies throughout a variety of macroeconomic environments. Typically, we are not making major adjustments to account for quarterly changes in economic conditions. That being said, we certainly look at specific structural issues that may arise and will elevate the emphasis we place on those factors, as necessary.

For instance, in our most recent review of the consumer finance industry in 2022, we outlined a series of macroeconomic headwinds that we considered likely to weigh heavily on consumer financial health. We then adjusted our model, which is comprised mostly of credit card companies, to place greater emphasis on measuring how well an institution prioritizes financial product suitability in its underwriting process and product delivery.

The importance of product safety

Product safety might not seem like a topic associated with financial services firms, but how well companies prioritize the suitability of a financial product or service may indicate how invested firms are in the success of their customers. This spans the entirety of the financial product lifestyle, including fair advertising, customer education, employee training in consumer protection laws, debt collection policies, and the complaint resolution process.

Better performance in these areas aligns with fewer violations and fines when firms run afoul of consumer protection laws. Moreover, we believe attention to these consumer issues is likely to result in higher customer retention, lower customer acquisition costs, and lower credit costs through the cycle.

Bottom line: We believe financial services institutions highly focused on the long-term suitability and financial health of their client base, with strong governance and human capital management, are better positioned to weather more challenging economic scenarios.