FROM COST TO OPPORTUNITY: THE ROLE OF ESG IN BANKING

Abstract

The multifaceted transformations related to ESG have received many labels, and, in this context, each country has chosen words and actions carefully so as to reflect their strategic interests. But from a financial perspective, ESG should answer the strategic question: is it profitable or not? Integration of ESG in banking requires additional investments, digital transformation, and innovation so as to enhance the sectors role in achieving sustainability goals. This paper aims to give a new perspective on the profitability related questions linked to ESG implementation. Using panel regression techniques on a sample of 98 banks with global reach and aggregated assets of more than 100 trillion dollars from the major financial centres of the world, we inspect whether ESG disclosure and its individual pillars have an impact on the financial performance of banking organisations. The results reflect that, at a holistic level, ESG tends to negatively influencing banks" financial performance, but considering a detailed view on each of its pillars, the results provide encouraging perspectives for all stakeholders and also lessons to be applied both top-down and bottomup by banking organisations. The article provides a comprehensive understanding of the implications for ESG profitability in the banking sector and emphasises the elements to be considered in finding the balance between cost and opportunity.

Headnote

Abstract

The multifaceted transformations related to ESG have received many labels, and, in this context, each country has chosen words and actions carefully so as to reflect their strategic interests. But from a financial perspective, ESG should answer the strategic question: is it profitable or not? Integration of ESG in banking requires additional investments, digital transformation, and innovation so as to enhance the sectors role in achieving sustainability goals. This paper aims to give a new perspective on the profitability related questions linked to ESG implementation. Using panel regression techniques on a sample of 98 banks with global reach and aggregated assets of more than 100 trillion dollars from the major financial centres of the world, we inspect whether ESG disclosure and its individual pillars have an impact on the financial performance of banking organisations. The results reflect that, at a holistic level, ESG tends to negatively influencing banks" financial performance, but considering a detailed view on each of its pillars, the results provide encouraging perspectives for all stakeholders and also lessons to be applied both top-down and bottomup by banking organisations. The article provides a comprehensive understanding of the implications for ESG profitability in the banking sector and emphasises the elements to be considered in finding the balance between cost and opportunity.

Keywords: banking, ESG (environmental, social, governance), financial performance

JEL Classification: C40, G15, G21, G32

(Proquest: ... denotes formula omitted.)

Introduction

The multiple crises that emerged during and after the Great Moderation (according to Fed (2013), the period corresponding to mid-1980s to 2007 years) transformed banking organisations in a way that doing business is useless without strong digital competences, especially in the post-global financial crisis years. Besides the complex technological changes, environmental, social and governance principles (ESG) have become an important element both inside and outside the banking sector, producing structural changes in the way banks operate and how they calibrate the long-term business strategies.

Given the global objectives of moving towards a more sustainable and resilient economy, the integration of ESG by banks is even more important, with banks' optimal management of ESG influencing the economy both directly, through their own risk management, and indirectly, through the financing of the economy and the activities of their clients.

Researchers have found that ESG principles improve companies" performance (Buallay, 2019; Broadstock et al., 2021). Other researchers contend that investment in a durable business could lead to opportunity costs associated with inefficiently allocated capital (Friedman, 1970; Aupperle et al., 1985; Devinney, 2009). In industries with small profit margins, understanding this relationship between sustainability-related factors and firm value could be the difference between profitability and default.

Understanding how ESG activity affects bank value is essential because events like the 2008 financial crisis and the LIBOR scandal (and also the march 2023 banking turmoil in US and Switzerland) eroded confidence in financial institutions and illustrate the complacency of both banks and competent authorities (De Larosicre et al., 2009; Hurley et al., 2014).

The aim of this study is to evaluate whether there is substantial evidence indicating that ESG disclosures and their individual components have a major impact on the financial performance of banks, both from a financial and a market point of view, using panel regression technique on a sample of banks spread globally, during the post-2015 Paris Agreement period.

The results highlight that all ESG pillars are important for banks' financial soundness, but the social dimensions emerge as exercising a significant positive influence at all analysed levels and for a large pool of stakeholders. This could be explained by the fact that whether the banking or academic community will label the transition either as "green", "sustainable" or "clean", the people, communities and markets are those that, in the end, matter the most and stick the real label.

Our analysis contributes to the literature using relevant available data and highlights the main ESG dimensions that affect both negatively and positively the financial performance of banks, while also providing directions for future research.

The paper is structured as follows. In the next section, we present the literature review and develop the tested hypotheses. The data description and methodology are given in Section 2, Sections 3 presents the estimates and discusses the results, and Section 4 concludes the paper.

1. Review of the scientific literature

Banks face increasing pressure from stakeholders and regulators to respond to climate change by reporting their environmental impacts and engage in initiatives to reduce their greenhouse gas emissions (Haque and Ntim, 2020). In responding to this emerging global pressure from stakeholders, banks are more interested in recognising climate change initiatives as means to increase their reputation, promote trust, credibility and improve their performance (Schultz et al., 2013; Dinu V and Bunea M, 2019; Chiaramonte et al., 2022).

Gold and Aifuwa (2022) observed that board meetings do not have an impact on bank sustainability reporting and recommends that issues on sustainability to be discussed in corporate board meetings regularly. Adu (2022) finds that sustainable banking initiatives and financial performance are significantly moderated by corporate governance mechanisms and that sustainability performance is mainly positive for banks with quality corporate governance. Despite the importance of board sustainability committees, prior studies exploring their impact on sustainability outcomes have been limited and provided mixed results (Berrone and Gomez-Mejia, 2009; Rodrigue and Cho, 2013; Biswas and Pandey, 2018; Orazalin, 2020; Tonescu-Feleaga, L et al., 2021; Orazalin et al., 2024).

Banks with higher emissions have more volatile deposits, leading to volatile return on assets (ROA) and higher bank instability. Banks are expected to maintain high levels of monitoring to provide a trustworthy signal of asset quality to stakeholders. Also, the good reputation is associated with long-term higher profitability and future credit quality (Ross, 2010; Bushman and Wittenberg-Moerman, 2012). Jung et al. (2018) argue that the carbon risk of a firm has a significant impact on its default risk due to the resulting uncertainties in its cash flows.

Weber (2014) conducted a study to explore ESG and financial performance in China. Using data from 75 Chinese firms over the period 2005-2012, he found a positive impact of ESG reporting on stock return. Deng and Cheng (2019) examined the impact of ESG rankings on the earnings of Chinese A-Share listed firms using data over the period 2011-2019 and reported a positive connection. They used the ESG rating reports issued by two Chinese rating agencies: SynTao Green Finance ESG rating index and China Alliance of Social Value Investment ESG rating index. The impact was found to be stronger for non-stateowned firms compared to state-owned firms and for firms in the secondary sector compared to those in the tertiary sector.

Liu et al. (2021) examined the linear and non-linear impact of ESG financial performance in the Chinese banking sector. Using the data of Chinese banks over the period 2009-2018, they reported a significant positive impact of governance score on return on equity and nominal interest margin profit; however, the composite ESG score, and environmental and social factors did not significantly affect return on assets.

Broadstock et al. (2021) found that ESG performance was positively related with the short term cumulative abnormal returns for the period following COVID-19 lockdown and illustrated the resilience of stocks for companies with high ESG performance during the turbulent times of market crisis. Contrary to these findings, Ruan and Liu (2021) found a negative impact of ESG ranking on the performance of China's Shanghai and Shenzhen listed companies. Their finding was based on the data for nonfinancial firms over the period 2015-2019 with ESG ratings, data using Tobin's Q as a performance indicator and dependent variable.

Yang et al. (2022) focus on sustainable development goals with sustainable practices followed by different industries in the G7 economies from 2010 to 2018 using panel estimators. For analysing the sustainable practices, ESG pillars were mainly under observation along with the green financing, green economic volatility, and clean energy as key determinants. The findings through the estimation of panel data confirm that ESG indicators play a significant and positive role in sustainable practices. At the same time, with the controlling effect of environmental regulations, foreign investment, and economic growth, the study provides policy implications for the ecological activists and other stakeholders, specifically in G7 economies while creating a linkage between green economy and financing, clean energy and sustainable practices.

El Khoury et al. (2021) focus on the banking sector of the Middle East, North Africa and Turkey region while exploring the trends in return on assets, return on equity, Tobin's Q, and stock returns through ESG indicators for 46 listed banks between 2007-2019. They also control for the bank-specific effect of ESG and quadratic term on financial performance. The findings of their study show a nonlinear association between ESG and the relationship between financial performance.

Chouaibi et al. (2021) evaluate ESG businesses and financial performance while investigating the mediating role of green innovation. Data were collected during 2005-2019 for the 115 companies in the UK and 90 companies working in Germany, selected from ESG index. The study findings confirm an increase in the value of those firms having strong ESG reporting compared to those with weak reporting. Furthermore, their findings also provided some interesting practical and academic implications specifically in the context of ESG reporting to leverage some future growth opportunities.

Apart from the conventional financial indicators, ESG scores are also critical to evaluate the riskiness of the firm (Apergis et al. 2022). Many credit rating agencies such as Moody's, SandP, and Fitch rate firms based on their ESG activities. Other studies in the banking sector show a positive role of "sustainable" banking governance practices in reducing the cost of debt financing (Agnese and Giacomini 2023). Firms with better ESG scores exhibit a lower cost of equity (Mulchandani et al. 2022) and have fewer capital constraints. Higher quality and quantity of ESG information benefits the capital markets by enhancing liquidity and lowering the cost of capital for the firm (Christensen et al. 2021).

Previous research on ESG criteria primarily focuses on the corporate perspective (Bourcet, 2020; Khanchel et al., 2023; Tsang et al., 2023). However, this review of the literature did not identify any references that support the perspective (the social component of ESG) or address their involvement in organisational management, as highlighted by Ouni et al. (2020).

Studies have shown that ESG disclosure has a significant positive impact on financial performance in the European banking sector, including ROA, ROE, and Tobin's Q (Buallay 2019). In a cross-national study, Lopez-de-Silanes et al. (2020) looked at ESG quality disclosure and found out that companies who perform well on ESG metrics are just being more transparent.

According to neoclassical theory, banks will face negative outcomes, such as increased expenses and intense competition, when investing in socially orientated projects (Gholami et al., 2022). Numerous studies have also discovered that, for various reasons that are mostly connected to high operating costs, ESG activities negatively affect bank performance (Crisóstomo et al. 2011; Byun 2018; Duque-Grisales and Aguilera-Caracuel 2021).

There are several hypotheses we need to focus on in order to analyse the impact of ESG on banking performance:

H1: The combined ESG and ESG pillars are important triggers that can lead to increased bank financial performance.

H2: The dimensions of ESG can influence the expected level of bank performance.

2. Research methodology

The sustainability discussion is raising the interest of all stakeholders in the financial sector, and banks are pushed forward in the green and climate transition towards a faster and more sustainable growth. But banks do not face the same pressure.

This paper aims to provide an updated global perspective on how the transition affects the financial performance of banks from an extended financial area: United States (US), Europe and Asia Pacific countries. In order to capture the multiple-faceted transformations of the banking sector in these areas, we developed the sample of banks using The world's largest banks by assets SandP ranking published on April 30, 2024. Considering the previously mentioned interest geographies, we selected all publicly listed banks with financial and Environmental, Social and Governance (ESG) data available in the Refinitiv and Orbis databases. We chose the Orbis database as it is often used in scientific research for financial data, while the Refinitiv database contains one of the most trusted and comprehensive ESG databases, with several historically available indicators and a clear and transparent methodology.

The final sample comprised 98 banking organisations with a global reach and aggregated assets of more than 100 trillion dollars with yearly financial and ESG indicators available for the 2017-2022 period.

For each ESG pillar we used also individual specific dimensions to ensure comparability within the same group variables and ensure the quality of the results: Environmental (E) - reduction in resources, environmental innovation, estimated emissions; Social (S) - product responsibility, workforce, employees; Governance (G) - CEO/chairman duality, board independence, diversity and compensation. The variables used in the analysis are presented in Table 2 and are separated into three categories:

We explained each financial performance variable using the definitions provided by the European Banking Authority in its Methodological guidance on risk indicators and analysis tools issued in 2019 and updated in 2023. The ESG indicators are defined using the information available on the Refinitiv website.

Banking organisations have known multiple transformative influences since the 2008 global financial crisis, i.e. development of digital banking, pressure from FinTech/BigTech companies, artificial intelligence, more frequent materialisation of non-financial risks. This changing environment poses a threat to the financial performance of banks, which make constant efforts to comply with customers` requirements.

As Hughes and Mester (2013) highlighted, there is no consensus among researchers regarding the measurement of financial performance in banking. Therefore, we based our mix of dependent variables on previously reviewed analyses like Azmi et al. (2021), Buallay et al. (2020) and Adu (2022).

We developed an extended sample of independent variables as each of these variables would form stronger links with different measures of financial performance. For the G pillar we used four dimensions (CEO/chairman duality, board gender diversity (%), independent board members, board member compensation), unlike the E and S pillars, for which we used three. This difference is justified by governance shortfalls like those from 2023 (Silicon Valley Bank, Silvergate Bank, Signature Bank, First Republic Bank for US market and Credit Suisse European market), by the fact that governance has a critical role in setting the tone of transformation within the banking organisation and that even after the hard lessons of multiple uncertainties, governance and control issues are still most numerous in supervision reports (Fed, 2024).

To further inspect the performance-ESG relationship, we included in our research two types of control variables. Bank specific control variables were used to control for internal bank characteristics that could mislead the relationships and ensure that results reflect the effects of the independent variables rather than the intrinsic factors. The country specific control variables were used given the inter/intra-regional differences in terms economic and technological development, intellectual property regimes, and macroeconomic specificities. To analyse the relationship between banks` financial performance and ESG indicators, we used panel regressions, which are optimal for capturing both cross-sectional and time-series variations, allowing for a more rigorous representation of unobserved heterogeneity across multiple entities and over a longer period of time. The panel regression, either with fixed or random effects, is frequently used in scientific literature, especially on corporate performance in banking. Baltagi (2009) considers that panel data give better results, decrease collinearity among variables and increase efficiency. Hence, panel data provide a better control of the impact of unobserved heterogeneity (Hsiao, 2022).

...

where:

yit - the dependent variable for unit i in period t,

α - the intercept,

β - the vector of coefficients for the independent variables,

Xit - the vector of independent variables for unit i and period t,

uit - the error term.

Panel regressions with random effects permit the assessment of two sources of diversity: between companies for the same year, and within each company over time (Bell and Jones, 2015). On the other hand, panel regressions with fixed effects allow the examination of the within-unit variation, assuming that the intercept is not a random value, meaning each company is significantly different from another in terms of their base levels for the dependent variable. To decide which model is more applicable, we used three tests for model specification in panel data: the Lagrange multiplier (to check if the model needs effects and to verify if they should be applied on cross-section or time series dimensions), the Hausman test (to choose between fixed and random effects) and the likelihood ratio (to determine whether fixed effects are needed). The panel regression tests indicated that cross section fixed effect must be applied on our models.

3. Results and discussion

The correlation between variables is presented for ESG pillars and the related dimensions in Tables 3.1 and 3.2.

The multicollinearity between variables was analysed using the correlation matrix and variables with a strong correlation (+/-0.4) were not included in the same model.

A higher correlation was observed between ESG Combined and its pillars, with the Soc pillar emerging as the most correlated. Regarding ESG pillars, we found a strong correlation between Soc and Env. The financial performance indicators ROE and ROA are strongly correlated with each other and TQ, while between ROA and LR there is a strong negative correlation. The last financial indicator (NIM) is also negatively correlated with LR, which was an expected result, given the common elements in the computational methodology.

The results of the analysis, presented in Table 4, highlight a complex relationship between banking performance and ESG, with all pillars reflecting the diverse impact they have on banking organisations. Table 4 presents the compressed results, as for each dependent variable four models were developed to explain bank performance.

The analysis highlights that ROE and ROA are not significantly influenced by ESG, Env and Soc, while the Gov has a significant positive impact on both of them. This result could be explained by the fact that ROE and ROA are financial indicators that measure performance only from an accounting perspective, which can and should be influenced by management decisions.

Considering the ESG dimensions, the results reflect that Env indicators (Env_RRT, Env_IS, Env_CO2) have a strong influence on both ROE and ROA, Env_RRT and Env_CO2 having a positive, but mixed impact, given the potential cost reduction and reputation improvements. On the other hand, during the analysed period, only ROE was significantly and positively influenced by Env_CO2, which suggests that banks still have in their portfolios carbon intensive customers that generate higher profits. As regards Env_IS, the analysis reflects a negative impact on both ratios, which could be explained by the fact that investments in new technologies and banking products that are environmentally friendly generate additional costs.

The social dimension of ESG has the same impact on both ROE and ROA, with Soc_WS and Soc_NoE exercising a significant influence, reflecting that the number of employees and job satisfaction are generating higher returns due to increased productivity.

The analysis highlights that between ROE/ROA indicators and CEO/chairman is a negative relationship, but only in relation to ROE it is statistically significant, due to the risk of power concentration and diminishing board independence (in line with Agent Theory), which could determine inappropriate management on a long term.

In terms of board gender diversity (Gov_BGD), the results are mixed, with a positive significant influence only in relation to ROA, which could explain that gender diversity can contribute to balanced decision-making in asset utilisation, with focus on sustainability and operational efficiency.

Board management compensation has a strong negative influence on both rentability ratios due to elevated payment costs. The results reflects that a balanced compensation with both variable and fixed part should be considered especially in the banking sector, which could increase risk behaviour/awareness and long term responsibility of the management. Thus, the compensation structure has a significant role in financial optimisation and should keep the balance between profitability and resilience, calibrating risk appetite and aligning stakeholders` interest.

In terms of stock market influences, the social pillar has a positive and significant impact at the 10% threshold on SMR. This fact can be explained by the desire of investors to buy shares of companies that care about their employees, which are considered more sustainable and ethical. Also, good social scores contribute to a better reputation of companies and thus better returns from the market value perspective.

On the Environment side, the ENV_IS dimension has a positive and significant impact on SMR because, as a rule, news about the innovation of certain processes or products is seen very favourably by investors, who associate the idea of innovation with efficiency, and therefore with better financial performance. Between ENV_CO2 and SMR there is an indirect relationship, significant at the 10% threshold, which means that a decrease in CO2 emissions will lead to an increase in returns. Considering the concerns at the global level to transforming businesses into much cleaner ones by reducing CO2 emissions, investors are also receptive to such actions by companies.

The indirect relationship between SOC_PRS and SMR can be explained by the fact that investors can perceive that product responsibility brings more costs than benefits. There are already regulations regarding the transparency of financial products, so that another focus on this aspect can be perceived by investors as an additional cost.

In the same direction with Soc, Soc_WS also has a positive impact on SMR because companies with high employees` job satisfaction are more valued on a long run by investors, due to reduced reputational risk, long-term stability and much better productivity of employees. At the same time, performing companies from a social perspective have much easier access to new markets for clients and partners, where social factors are highly valued.

Between SMR and Soc_NoE there is an indirect relationship, most likely caused by the continuous pressure of automation and digitalisation of processes in the banking sector. Thus, a decrease in the number of employees can mean a better operational efficiency, i.e. the reduction of some costs in parallel with the increase of profit margins, reducing the operational cost and risk.

The direct relationship from Gov_CCD can be due to the acceleration and efficiency of the decision-making process, and at the same time there is a stronger leadership that can withstand the challenges of the market.

Between GOV_BGD and SMR there is a direct relationship that is due to the fact that gender diversity brings with it a diverse range of skills and experiences that materialize in much better decision-making. Also, companies that have women on the board tend to have a better reputation and a lower risk from the governance perspective, a fact highly appreciated by investors.

Usually, the remuneration of the board members is closely related to the performance achieved, so that if they are properly compensated, they can lead to better performances from a financial perspective, a fact that contributes to the consolidation of investors' confidence and to the increase of the share price in the long run.

Regarding the TQ, which measures market performance in relation to the accounting value of assets, the results emphasize a mixed market perception, based on different ESG component, highlighting a complex interaction.

The ESG Combined indicator has a significant negative impact on TQ, suggesting that aggregated Env, Soc and Gov are perceived as market value diminishing in the short-term, given the additional related costs. The investors might consider ESG implementation as an operational constraint, which affects the market value.

In relation to the ESG pillars, the results emphasize a more detailed perspective on the interaction between TQ and ESG. The Env dimension has a positive and significant influence, suggesting that investors perceive environmental initiatives as having the potential to increase the market value. This correlation underscores that clean technologies and environmental awareness improve reputation and respond to stakeholders' requests.

Also, the Gov pillar is highly influential on the ESG Combined score, validating the idea that corporate governance has a clear and significant role in market performance. A sound governance function is based on transparency, responsibility and efficiency and sets the tone in all critical lines of banking activity, from customer support to risk management, and is associated with a positive market sentiment.

As regards the Soc dimension, the results indicate that employee-centred policies and other socially responsible activities are perceived by investors as having small short-term benefits, still emphasising that as long as an activity cannot be translated into profit, market participants are not very interested.

As regards NIM, the results highlight sensitivity to ESG, especially to the environmental component, where there is a negative relationship, due to the fact that market competitiveness generated lower interest rates for green loans and as a result of the post- 2015 Paris Agreement incentives for environmentally clean investments.

Also, for managing the climate risks there are needed significant investments, which cand generate higher costs and compress the margins.

On the sample analysed, the impact of Soc and Gov didn't bring significant impact, but still, reducing funding costs can improve the margins because of the reputation and customer loyalty, while a good corporate governance with improved internal flows might reduce default rates and credit losses.

The Env_IS, which reflects the capacity to create new market opportunities, implies big technology and infrastructure investments, which can diminish the margins on the short term.

But having an environmental innovation strategy, on the long term, can impact NIM by driving development of new and innovative green products, decreased funding costs, improving risk adjusted returns, which can be translated into positive effects on a long run, positioning banks for sustainable development and growth.

A better workforce score (Soc_WS) could improve operational efficiency. For the analysed sample, we can see a negative relationship between Soc_WS and net interest margin, which could suggest that a large but less efficient workforce may grow operational costs and reduce NIM.

Soc_NOE has a positive relation with NIM, because the number of employees can have an impact depending on the bank structure. For example, if the workforce increase, the impact is in increasing the operational and salary costs, which put a pressure on the NIM if the productivity doesn't scale accordingly.

Consequently, in the analysed period, because of the digital transformation and lowering internal costs, we found a positive relationship between the number of employees and net interest margin.

The chairman duality has a positive relation with NIM because it brings an efficient decision making, improving internal processes and quicker implementation of ESG strategies. Also, chairman duality strengthens the corporate governance. Independent board members assure a better corporate governance by mitigating the excessive risk taking, which is translated in a better risk management, a better credit quality, reducing the provisions and indirectly supports the growth of NIM.

An optimal independent board generally experiences a better corporate governance by improving better strategies on a long term.

Linking the net interest margin with the board compensation usually prioritises strategies that optimise loan pricing and cost efficiency. Generous compensations structures increase governance costs, which could marginally lower NIM.

Based on the results presented above, the first research hypothesis (H1) is partially confirmed. ESG Combined and ESG pillars impact the chosen dependent variables differently. Thus, Gov has a positive impact on ROE, ROA and TQ, Soc positively influences only SMR, and Env has a positive impact only on TQ. The ESG combined negatively and significantly influences TQ and NIM. The second research hypothesis (H2) is also partially confirmed, with the dimension of ESG influencing all chosen dependent variables chosen, except SMR.

Conclusions

Research provides valuable insights to coordinate cost allocation with investments to generate opportunities. The continuous banking transformation process has imposed the ESG principles as a sine qua non condition for long-term success. The authorities and both the banking and academic communities promote the idea that ESG builds resilience and trust, providing a solid foundation for future growth and also a good financial performance. As global ESG standards and investor expectations evolve, banks that prioritize a sustainable growth will lead the way in redefining the financial sector, while they promote social responsibility and act ethically when interacting with all stakeholders.

For the ESG to be profitable in banking, an integrated and long-term approach is needed, combining financial and nonfinancial risk management, customer engagement, and strategic communication. For safeguarding the operations and customer confidence, the banking organisations have to ensure a permanent balance between stable revenues, while mitigating unexpected losses.

On a holistic level, contrary to the public perception, ESG tends to be negatively influencing banks` financial performance, although the influence is not significant in all cases. The perception is that ESG is a relatively new topic banks have to comply with and for this interdependence to be positive, structural changes should be performed in relation to policies, processes and, most importantly, people.

The transition to ESG brings new opportunities and implies big investments in technology and infrastructure, which can diminish the margins, at least in the short term. But on the long run, developing socially responsible banking products, prioritising "clean" exposures and improving risk adjusted returns could be translated into a sustainable development and growth for the banking sector and regaining the trust lost during crises.

The Social dimensions of ESG emerge as exercising a significant positive influence at all analysed levels and for a large pool of stakeholders, registering the highest correlation score between ESG (at aggregated level) and its pillars. This could be explained by the fact that whether the banking or academic community will label the transition either as "green", "sustainable" or "clean", the people, communities and markets are those that, in the end, matter the most and stick the real label.

On the governance side, the analysis reveals that, despite expectations, board member compensation has a strong negative influence on the accounting financial performance. This should be an indication even for risk management purposes, as crises are not triggered by low payroll, but by the lack of risk behaviour and awareness. The role of governance is critical, and transparency, efficiency and responsibility should be key components for a new line of defence system, one that is accustomed to increased volatility and new ways in which risks materialise.

The environmental pillar revealed that, despite the increasing number of regulations (especially in Europe) and public initiatives, it does not have sufficient strength to bring also financial benefits for shareholders. Only at a market level the results indicate a positive reaction, although not significant. This emphasises that the transition cannot be done only with banks, because they will not have profits on this, but policymakers should find another way to finance the complex transformations needed.

Whether we associate it with "green" or not, the ESG is a complex mechanism and generates mixed results when it is in relation to banking organisations. It is not only a pathway to financial soundness and organisational resilience, but also a cornerstone for banking organisations in their competitive positioning in the evolving global financial landscape.

The results could be a potential baseline for developing policies related to the ESG integration in banking business. Considering the data analysed, for a sample of 98 banks with a global reach, and extended pool of variables, this study enhances the sustainability related knowledge and awareness among investors, policymakers and research scholars.

The main limitation in conducting this research is data availability, which is the reason why the number of periods is only 6 years. It is known that there is a gap of minimum one year between the latest financial and ESG data available. Also, we had to reduce our sample due to the fact that not so many companies have publicly available ESG data.

In terms of further research, expanding the sample, adding dummy variables to observe the effects of geographical areas or economic crises, testing other variables as well as including interaction variables in regression models may represent some directions for the development of the literature on this topic.

Sidebar

Please cite this article as: Niţescu, D.C., Ciobanu, R., C&acaron;lin, A.E., Rusu, A.G. and Vierescu, E.M., 2025. From Cost to Opportunity: The Role of ESG In Banking. Amfiteatru Economic, 27(68), pp. 235-252.

Article history

Received: 17 September 2024

Revised: 27 November 2024

Accepted: 20 Dece mber 2024

Footnote

*· Corresponding author, Adina Elena C&acaron;lin - e-mail: [email protected]

References

References

Adu, D.A., 2022. Sustainable banking initiatives, environmental disclosure and financial performance: The moderating impact of corporate governance mechanisms. Business Strategy and the Environment, 31(5), 2365-2399.

Agnese, P. and Giacomini, E., 2023. Bank's funding costs: Do ESG factors really matter? Finance Research Letters, [e-journal] 51, article no. 103437. https://doi.org/10.1016/ j.frl.2022.103437.

Apergis, N., Poufinas, T. and Antonopoulos, A., 2022. ESG scores and cost of debt. Energy Economics, [e-journal] 112, article no. 106186. https://doi.org/10.1016/ j.eneco.2022.106186.

Aupperle, K.E., Carroll, A.B. and Hatfield, J.D., 1985. An empirical examination of the relationship between corporate social responsibility and profitability. Academy of Management Journal, [e-journal] 28(2), pp.446-463. https://doi.org/10.2307/256210.

Azmi, W., Hassan, M.K., Houston, R. and Karim, M.S., 2021. ESG activities and banking performance: International evidence from emerging economies. Journal of International Financial Markets, Institutions and Money, [e-journal] 70, article no. 101277. https://doi.org/10.1016/j.intfin.2020.101277.

Baltagi, B.H., 2009. Econometric Analysis of Panel Data: A Companion to Econometric Analysis of Panel Data. John Wiley and Sons Incorporated.

Bell, A., and Jones, K., 2015. Explaining fixed effects: Random effects modeling of timeseries cross-sectional and panel data. Political Science Research and Methods, 3(1), 133-153.

Berrone, P. and Gomez-Mejia, L.R., 2009. Environmental Performance and Executive Compensation: An Integrated Agency-Institutional Perspective. Academy of Management Journal, [e-journal] 52(1), pp.103-126. https://doi.org/10.5465/ amj.2009.36461950.

Biswas, P.K., Mansi, M. and Pandey, R., 2018. Board composition, sustainability committee and corporate social and environmental performance in Australia. Pacific Accounting Review, [e-journal] 30(4), pp.517-540. https://doi.org/10.1108/PAR-12- 2017-0107.

Bourcet, C., 2020. Empirical determinants of renewable energy deployment: A systematic literature review. Energy Economics, [e-journal] 85, article no. 104563. https://doi.org/10.1016/j.eneco.2019.104563.

Broadstock, D.C., Chan, K., Cheng, L.T.W. and Wang, X., 2021. The role of ESG performance during times of financial crisis: Evidence from COVID-19 in China. Finance Research Letters, [e-journal] 38, article no. 101716. https://doi.org/10.1016/j.frl.2020.101716.

Buallay, A., 2019. Sustainability reporting and firm's performance: Comparative study between manufacturing and banking sectors. International Journal of Productivity and Performance Management, [e-journal] 69(3), pp.431-445. https://doi.org/10.1108/ IJPPM-10-2018-0371.

Buallay, A., Fadel, S.M., Al-Ajmi, J.Y. and Saudagaran, S., 2020. Sustainability reporting and performance of MENA banks: is there a trade-off? Measuring Business Excellence, [e-journal] 24(2), pp.197-221. https://doi.org/10.1108/MBE-09-2018-0078.

Bushman, R.M. and Wittenberg- Moerman, R., 2012. The Role of Bank Reputation in "Certifying" Future Performance Implications of Borrowers' Accounting Numbers. Journal of Accounting Research, [e-journal] 50(4), pp.883-930. https://doi.org/10.1111/j.1475-679X.2012.00455.x.

Byun, H.-Y., 2018. Impact of ESG factors on firm value in Korea. Journal of international trade and commerce, 14(5).

Chiaramonte, L., Dreassi, A., Girardone, C. and Piserà, S., 2022. Do ESG strategies enhance bank stability during financial turmoil? Evidence from Europe. The European Journal of Finance, [e-journal] 28(12), 1173-1211. https://doi.org/10.1080/1351847X.2021.1964556.

Chouaibi, S., Chouaibi, J. and Rossi, M., 2021. ESG and corporate financial performance: the mediating role of green innovation: UK common law versus Germany civil law. EuroMed Journal of Business, [e-journal] 17(1), pp.46-71. https://doi.org/10.1108/EMJB-09-2020-0101.

Christensen, H.B., Hail, L. and Leuz, C., 2021. Mandatory CSR and sustainability reporting: economic analysis and literature review. Review of Accounting Studies, [e-journal] 26(3), pp.1176-1248. https://doi.org/10.1007/s11142-021-09609-5.

Crisóstomo, V.L., de Souza Freire, F. and De Vasconcellos, F.C., 2011. Corporate social responsibility, firm value and financial performance in Brazil. Social responsibility journal, [e-journal] 7(2), 295-309. https://doi.org/10.1108/17471111111141549.

De Larosière, J., Balcerowicz, L., Issing, O., Masera, R., McCarthy, C., Nyberg, L., Ruding, O., 2009. Report of the high-level group on financial supervision in the EU. European Commission, Brussels.

Deng, X. and Cheng, X., 2019. Can ESG Indices Improve the Enterprises' Stock Market Performance? An Empirical Study from China. Sustainability, [e-journal] 11(17), article no. 4765. https://doi.org/10.3390/su11174765.

Devinney, T.M., 2009. Is the socially responsible corporation a myth? The good, the bad, and the ugly of corporate social responsibility. The Academy of Management Perspectives, 23(2), pp. 44-56.

Dinu, V. and Bunea, M., 2019. The corporate social responsibility of the Romanian banking system, Economics and Management, Vol. 22, No. 4, pp 119-133, https://doi.org/10.15240/tul/001/2019-4-008

Duque-Grisales, E. and Aguilera-Caracuel, J., 2021. Environmental, Social and Governance (ESG) Scores and Financial Performance of Multilatinas: Moderating Effects of Geographic International Diversification and Financial Slack. Journal of Business Ethics, [e-journal] 168(2), pp.315-334. https://doi.org/10.1007/s10551-019-04177-w.

El Khoury, R., Nasrallah, N. and Alareeni, B., 2023. ESG and financial performance of banks in the MENAT region: concavity-convexity patterns. Journal of Sustainable Finance and Investment, [e-journal] 13(1), pp.406-430. https://doi.org/10.1080/20430795.2021.1929807.

Federal Reserve, 2013. The Great Moderation. [online]. Available at: https://www.federalreservehistory.org/essays/great-moderation> [Accessed 11 October 2024].

Federal Reserve, 2024. Supervision and Regulation Report. [online]. Available at: < https://www.federalreserve.gov/publications/files/202411-supervision-and-regulationreport. pdf > [Accessed 17 September 2024].

Friedman, M., 1970. A Theoretical Framework for Monetary Analysis. Journal of Political Economy, [e-journal] 78(2), pp.193-238.

Gholami, A., Sands, J. and Rahman, H.U., 2022. Environmental, Social and Governance Disclosure and Value Generation: Is the Financial Industry Different? Sustainability, [e-journal] 14(5), article no. 2647. https://doi.org/10.3390/su14052647.

Gold, N.O. and Aifuwa, H.O., 2022. Board Meeting and Sustainability Reporting of Banks in Nigeria. Copernican Journal of Finance and Accounting, [e-journal] 11(3), 49-67. https://doi.org/10.12775/CJFA.2022.013.

Haque, F. and Ntim, C.G., 2020. Executive compensation, sustainable compensation policy, carbon performance and market value. British Journal of Management, [e-journal] 31(3), 525-546. https://doi.org/10.1111/1467-8551.12395.

Hsiao, C., 2022. Analysis of panel data. Cambridge university press.

Hughes, J.P. and Mester, L.J., 2013. Measuring the Performance of Banks: Theory, Practice, Evidence, and Some Policy Implications. SSRN Electronic Journal. [e-journal] https://doi.org/10.2139/ssrn.2306003.

Hurley, R., Gong, X. and Waqar, A., 2014. Understanding the loss of trust in large banks. International Journal of Bank Marketing, [e-journal] 32(5), pp.348-366. https://doi.org/10.1108/IJBM-01-2014-0003.

Ionescu F.L., Ionescu, B.S. and Bunea, M., 2021. Exploring The Romanian Students' Intention to Use the Internet of Things For Sustainable Education, Economic Computation And Economic Cybernetics Studies And Research, Volume 55, Issue 2, pp. 109-123, https://doi.org/10.24818/ 18423264/55.2.21.07

Jung, J., Herbohn, K. and Clarkson, P., 2018. Carbon Risk, Carbon Risk Awareness and the Cost of Debt Financing. Journal of Business Ethics, [e-journal] 150(4), pp.1151-1171. https://doi.org/10.1007/s10551-016-3207-6.

Khanchel, I., Lassoued, N. and Baccar, I., 2023. Sustainability and firm performance: the role of environmental, social and governance disclosure and green innovation. Management Decision, [e-journal] 61(9), pp.2720-2739. https://doi.org/10.1108/MD-09-2021-1252.

Liu, Y., Saleem, S., Shabbir, R., Shabbir, M.S., Irshad, A. and Khan, S., 2021. The relationship between corporate social responsibility and financial performance: a moderate role of fintech technology. Environmental Science and Pollution Research, [e-journal] 28(16), pp.20174-20187. https://doi.org/10.1007/s11356-020-11822-9.

Lopez-de-Silanes, F., McCahery, J.A. and Pudschedl, P.C., 2020. Esg Performance and Disclosure: A Cross-Country Analysis. Singapore Journal of Legal Studies, [e-journal] pp.217-241.

Mulchandani, K., Mulchandani, K., Iyer, G. and Lonare, A., 2022. Do Equity Investors Care about Environment, Social and Governance (ESG) Disclosure Performance? Evidence from India. Global Business Review, [e-journal] 23(6), pp.1336-1352. https://doi.org/10.1177/09721509221129910.

Orazalin, N., 2020. Do board sustainability committees contribute to corporate environmental and social performance? The mediating role of corporate social responsibility strategy. Business Strategy and the Environment, [e-journal] 29(1), pp.140-153. https://doi.org/10.1002/bse.2354.

Orazalin, N.S., Ntim, C.G. and Malagila, J.K., 2024. Board Sustainability Committees, Climate Change Initiatives, Carbon Performance, and Market Value. British Journal of Management, [e-journal] 35(1), pp.295-320. https://doi.org/10.1111/1467-8551.12715.

Ouni, Z., Ben Mansour, J. and Arfaoui, S., 2020. Board/Executive Gender Diversity and Firm Financial Performance in Canada: The Mediating Role of Environmental, Social, and Governance (ESG) Orientation. Sustainability, [e-journal] 12(20), article no. 8386. https://doi.org/10.3390/su12208386.

Rodrigue, M., Magnan, M. and Cho, C.H., 2013. Is Environmental Governance Substantive or Symbolic? An Empirical Investigation. Journal of Business Ethics, [e-journal] 114(1), pp.107-129. https://doi.org/10.1007/s10551-012-1331-5.

Ross, D.G., 2010. The "Dominant Bank Effect:" How High Lender Reputation Affects the Information Content and Terms of Bank Loans. Review of Financial Studies, [e-journal] 23(7), pp.2730-2756. https://doi.org/10.1093/rfs/hhp117.

Ruan, L. and Liu, H., 2021. Environmental, Social, Governance Activities and Firm Performance: Evidence from China. Sustainability, [e-journal] 13(2), article no. 767. https://doi.org/10.3390/su13020767.

Schultz, F., Castelló, I. and Morsing, M., 2013. The construction of corporate social responsibility in network societies: A communication view. Journal of business ethics, [e-journal] 115, 681-692. https://doi.org/10.1007/s10551-013-1826-8.

Tsang, Y.P., Fan, Y. and Feng, Z.P., 2023. Bridging the gap: Building environmental, social and governance capabilities in small and medium logistics companies. Journal of Environmental Management, [e-journal] 338, article no. 117758. https://doi.org/10.1016/j.jenvman.2023.117758.

Yang, Q., Du, Q., Razzaq, A. and Shang, Y., 2022. How volatility in green financing, clean energy, and green economic practices derive sustainable performance through ESG indicators? A sectoral study of G7 countries. Resources Policy, [e-journal] 75, article no. 102526. https://doi.org/10.1016/j.resourpol.2021.102526.

Weber, O., 2014. Environmental, Social and Governance Reporting in China. Business Strategy and the Environment, [e-journal] 23(5), pp.303-317. https://doi.org/10.1002/bse.1785.