The fine line between ESG commitment and bank performance

Abstract

The paper explores the implications of banks committing to an environmental, social, and governance (ESG) agenda on their operations and performance. Given the resource and operational requirements needed to support ESG-related initiatives and outcomes, we assess the level of operational distortion for banks with similar ESG profiles, identifying distinct classification groups. We find that higher levels of ESG commitment are associated with higher levels of distortion in bank operations. Further analysis reveals that this distortion in operations interferes with banks' management of assets and liabilities, ultimately affecting bank performance. We show that operating expenses increase with the level of ESG commitment, without a corresponding response in shareholder returns. We also find that, despite the importance of banking in financing brown industries, dropping the Environmental pillar has a negligible effect on our analysis, raising concerns about the informational value of the pillar. We conclude that transitioning to an ESG-oriented business model for a bank requires careful planning to manage the substantial operational and financial costs, while care needs to be taken with respect to the Environmental dimension to effectively reflect the associated risks.