Nexus between Sustainability Initiatives and Bank Asset Quality: Evidence from Emerging Market

Abstract

Sustainability and resilience of banks is essential for promoting economic growth and stability of any economy, especially developing economy. Good quality loan portfolio is a key requisite for bank’s stability. Studies have linked ESG adoption to financial performance and value creation. We use non-performing loans (NPLs) as a measure of bank asset quality to examine empirically the impact of Environmental, Social, and Governance (ESG) considerations on the sustainability and credit risk profile of Indian banks. NPL levels highlight systemic risks, erode depositor confidence, and jeopardize financial stability because bank solvency is heavily reliant on loan portfolio performance. We analyzed 28 scheduled commercial banks and 14 bank specific variables for ESG, loan quality and governance over a five-year period. The ESG disclosure -NPL nexus is examined using static fixed-effects and dynamic System GMM estimations.  We find that NPL ratios are negatively and significantly impacted by aggregate ESG disclosures. Disaggregated analysis shows that governance-related indicators have the greatest explanatory power while social indicators and environmental disclosures have limited impact. Additionally, our study brings out the role of board independence in reducing bad loans. The results imply that ESG practices, especially governance mechanisms, can promote sustainability outcomes of banks in emerging market environment.