ESG and Financial Stability in the Banking Sector

Abstract: The banking sector is experiencing an increasing interest in evaluating environmental performance, social responsibility, and corporate governance (ESG), since the internationalcontext aroused discussions on advantages of incorporating ESG-related policies. Therefore,significant relationships between ESG engagement and financial performance and stabilityare expected. This study aims to analyse the impact of ESG engagement on financial stabilityin the banking sector including the period of economic distress. A sample size of 72 listedEuropean banks is studied during the period 2017-2022, using regression analysis. Z-score,Non-performing loan ratio and Tobin’s Q are proxies used to measure banks’ financialstability. Combined ESG score and individual Social, Environmental, and Governance pillarsfrom Refinitiv Eikon database are the target variables. Contrary to expectations, the findingsreveal that ESG engagement does not have a significant positive impact on financial stabilitywithin the banking sector. However, interestingly, among the three ESG pillars the social oneseems to decrease financial stability of banks in some estimations. It is also notable that theregression coefficients for target variables are quite low, especially in comparison withfinancial performance variables ROA and ROE, which indicates that ESG engagement maynot be the most influential factor in banks’ financial stability.