The Effect of ESG on The Financial Sector

Abstract

This paper explores the intricate impact of ESG (Environmental, Social, and Governance) factors on the stability of banks across different continents, with a specific focus on distinguishing the effects on both conventional and Islamic banking institutions. Our comprehensive empirical analysis reveals a substantially positive influence of ESG activities on the stability of both types of financial institutions. Notably, after employing pooled and fixed estimator regressions, the findings highlight the significantly positive effect of lagged ESG scores on the stability of conventional and Islamic banks, signifying the potential for ESG performance to enhance their overall stability. Further examination shows that the environmental pillar score, particularly in the conventional banking sector, displays highly positive and statistically significant outcomes, emphasizing the constructive impact of environmentally responsible practices. Conversely, the social pillar exhibits a positive correlation with the z-score in the Islamic banking segment, indicating that banks actively involved in community service and social responsibility initiatives experience improved stability. In conclusion, our study underscores the transformative potential of ESG activities in positively shaping both the external perception and internal operations of banks, ultimately contributing to increased valuations and improved stability.