Do Environmental, Social, and Governance (ESG) practices help mitigate bank default risk?

The study aims to investigate the ESG practices and bank default risk nexus in India, considering both short-term and long-term perspectives. Employing panel data covering 27 Indian banks spanning from 2012-13 to 2021-2022, the research utilizes the two-step 'system GMM' approach to examine the nexus above. A bank's ESG practices are found to be associated negatively with its default risk. This association holds for individual pillars of ESG, except for the environmental pillar. Notably, no evidence supports reverse causality, indicating that a bank's default risk does not appear to impact its ESG practices. The findings align with the hypothesis that ESG practices help mitigate default risk in banks. Embracing this hypothesis could provide policymakers and regulators with a foundation for influencing banks to integrate ESG practices into their operational frameworks more extensively. The consistent sign of coefficients for the ESG variables across short-run and long-run periods suggests stability in the relationship between ESG variables and bank default risk. However, the long-run coefficients exert a more substantial impact than their short-run counterparts. Therefore, strategically adopting ESG practices can fetch a competitive advantage by reducing default risk for banks, especially over the long term. Given the time required for ESG initiatives to yield results, evaluating their impact on bank default risk is most effectively accomplished with a focus on the long term. Among the ESG pillars, the Governance (G) pillar exhibits the most potent negative impact. In contrast, the Environment (E) pillar demonstrates the mildest negative effect on bank default risk in both short-run and long-run contexts. These outcomes are expected as governance significantly influences a bank's risk-taking behaviour, while the direct environmental impacts of banking activities tend to be relatively limited.