ESG activities and their influence on commercial banks’ profitability and financial stability

Abstract

PURPOSE: The ESG (Environmental, Social, and Corporate Governance) activities are a key element of the transformation of the financial system, particularly in the face of challenges arising from the 2007-2009 crisis and the COVID-19 pandemic. Consequently, the integration of environmental, social, and corporate governance aspects has been recognized as essential in shaping economic processes. This study contributes to the ongoing debate on ESG activities in the banking sector. The research aims to assess the impact of ESG implementation on the profitability and financial stability of commercial banks globally. The study examines whether ESG-related activities contribute to an increase in the market value of banks, reflecting higher profitability and improved financial stability. METHODOLOGY: The study encompasses financial and ESG data from 384 commercial banks across 62 countries worldwide, spanning the period from 2012 to 2021. The research sample is limited to banks for which ESG data is available in the Refinitiv Eikon database. A panel regression method is used to achieve the research objective. RESULTS: The results reveal a statistically significant relationship between the implementation of ESG activities and banks’ financial performance. The research indicates a negative impact of ESG activities, particularly in the social and governance dimensions, on banks’ profitability, measured by ROA and ROE. This negative relation may result from the substantial costs related to implementing ESG initiatives, regulatory pressures aimed at enhancing environmental protection, and the risks associated with financing green investments. Moreover, the uneven influence of the individual E, S, and G components may also contribute to the observed financial outcomes. Conversely, certain ESG activities, especially those related to the social dimension, are positively linked to banks’ financial stability, as reflected by the Z-score index, suggesting increased institutional resilience to systemic risk. These findings suggest a growing disparity between the short-term financial performance and long-term stability of banks involved in ESG activities. IMPLICATIONS: The study highlights the importance of ESG in enhancing bank stability and supporting sustainable finance. It provides a theoretical contribution by linking ESG with banks’ financial resilience and a practical contribution by promoting regulations and greater transparency in ESG-based business decision-making. Banks and policymakers can utilize the obtained findings to design strategic frameworks that integrate ESG factors into profitability measures, risk management processes, capital adequacy assessments, and long-term value creation. By incorporating ESG metrics into supervisory practices and disclosure requirements, financial institutions may enhance resilience against systemic shocks while fostering trust among stakeholders and aligning with global sustainability goals. ORIGINALITY/VALUE: This study makes a unique contribution to the literature by demonstrating a direct relationship between ESG practices and the profitability and stability of commercial banks. It extends previous research on the link between ESG activities and banks’ operational activities, particularly financial security.