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

Area of Science:

• Financial Economics
• Corporate Social Responsibility
• Risk Management

Background:

• Bank default risk poses systemic threats to financial stability.
• Integrating Environmental, Social, and Governance (ESG) factors is increasingly critical for sustainable banking.
• Understanding the nexus between ESG practices and bank default risk in emerging economies like India is vital.

Purpose of the Study:

• To investigate the relationship between ESG practices and bank default risk in the Indian banking sector.
• To analyze both short-term and long-term effects of ESG on default risk.
• To examine the impact of individual ESG pillars (Environmental, Social, Governance) on bank default risk.

Main Methods:

• Utilized panel data for 27 Indian banks from 2012-13 to 2021-2022.
• Employed the two-step system Generalized Method of Moments (GMM) for robust estimation.
• Assessed causality to ensure ESG practices influence default risk, not vice versa.

Main Results:

• ESG practices are negatively associated with bank default risk.
• The Governance pillar shows the strongest risk mitigation effect, while the Environmental pillar has the mildest.
• No evidence of reverse causality was found; default risk does not significantly impact ESG practices.

Conclusions:

• ESG integration can effectively mitigate bank default risk in India.
• Policymakers should encourage broader adoption of ESG practices in banking operations.
• Long-term strategic adoption of ESG offers a competitive advantage by reducing default risk.