Liquidity Creation, Bank Funding, and Risk-Taking: The Role of ESG

Abstract

This dissertation explores two critical types of risks faced by banks that include liquidity risk and credit risk. Furthermore, it tests whether bank regulations such as adopting the environmental, social, and governance (ESG) standards in addition to diversifying funding resources play crucial roles in mitigating them. Also, this dissertation aims to provide evidence of whether these risks vary depending on banks sizes. The final sample consists of 136 U.S. commercial banks covering the period from 2005 to 2022. Furthermore, a variety of econometric methods are applied that include OLS regression, random effects (RE), two-step system Generalized Method of Moments (GMM), regression discontinuity (RD), the bias-corrected Least- Squares with Dummy Variables (LSDVC), and the Two-Stage Least Squares regression (2SLS). The first chapter investigates whether ESG performance plays a mediating role in the effect of funding costs on bank liquidity creation. The findings of this chapter reveal that funding costs significantly reduce liquidity creation, implying that higher funding costs decrease banks’ ability to create liquidity. Additionally, adopting ESG principles increases banks’ ability to create more liquidity. Moreover, ESG performance of the sampling banks plays a significant role in mediating the relationship between funding costs and liquidity creation, which implies that depositors accept low interest payments due to the good ESG performance of the sampling banks, which suggests increasing the ability of the sampling banks to create liquidity. The second chapter examines the effect of bank liquidity creation and bank funding diversification on bank risk-taking, as represented by non-performing loans (NPLs). Moreover, the chapter aims to explore the mediating role of bank size in these relationships. The findings of this chapter show that NPLs increase significantly as the sampling banks create more liquidity. Furthermore, funding diversification significantly reduces NPLs and enhances the stability of the sampling banks. Finally, bank size significantly moderate the impact of bank liquidity creation and bank funding diversification on NPLs, which is more evident for the case of large banks.