ESG and asset quality in the banking industry: the moderating role of financial performance

Abstract

This paper aims to analyse the relationship between ESG and bank asset quality and the moderating role of profitability. We examine an international sample of 96 banks located in 33 countries using quarterly data covering the 2017-Q4 - 2022-Q3 period. Our findings show the existence of a positive ESG - asset quality relationship, which can be even reversed for particularly high levels of profitability. Moreover, we report significant differences between banks located in the European Union (EU) and in non-EU countries. We contribute to the literature by analysing the ESG - asset quality relationship, which has been hitherto largely overlooked, and we are the first quantifying how the marginal effect of ESG on asset quality varies depending on the level of profitability. Our findings have important policy and managerial implications in that banks should not only implement (and be pushed to implement) better ESG strategies, but also stabilise their financial performance, avoiding unsustainable short-term profits that could reverse the beneficial effects of ESG on asset quality.