An empirical investigation of banks’ sustainability performance under economic policy uncertainty

ABSTRACT

This paper empirically explores the effect of policy-related economic uncertainty on banks’ sustainability performance, measured by bank-level environmental, social, and governance (ESG) ratings. Based on a sample of U.S. banks, the results indicate that high economic policy uncertainty (EPU) increases banks’ overall ESG scores, supporting the stakeholder perspective of corporate philanthropic engagement. This positive effect seems regardless of bank size and remains valid across the environmental and social dimensions of ESG. The results survive a battery of robustness tests using alternative measures of EPU and ESG, introducing additional control variables, and using sub-samples based on the adoption of a major climate policy agreement. Documenting fresh evidence on the ESG-EPU relationship for U.S. banks at the national level, our paper provides strong incentives for future research on sustainable banking practices under economic policy risk in regional and global settings.

KEYWORDS:

• Sustainability performance
• ESG
• economic policy uncertainty
• banks

JEL CLASSIFICATION:

• D80
• G21
• M14

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1 For more information: https://www.bis.org/statistics/consstats.htm

2 Source: https://www.statista.com/statistics/265135/market-capitalization-of-the-banking-sector-worldwide/

3 Source: https://www.jpmorgan.com/solutions/cib/insights/esg

4 Source: https://mitsloan.mit.edu/ideas-made-to-matter/big-banks-embrace-sustainable-investing-change-slow

5 Numerous studies empirically prove a negative impact of EPU on bank lending growth (e.g., Hu and Gong 2019; Bordo, Duca, and Koch 2016; Chi and Li 2017; Shabir et al. 2022; Nguyen, Le, and Su 2020). Tran et al. (2021b) argue that banks use derivatives less intensively during periods of high EPU. Xu (2020) and Cui et al. (2021), among others, report that firm-level innovation is significantly negatively associated with increased EPU. Alam, Farjana, and Houston (2023b) find that local EPU at the U.S. state level significantly hinders firm financial stability, and this effect is regardless of firm size.

6 We chose U.S. banks as they represent the majority of our ESG and banking data.

7 Although the terms CSR and ESG are often used interchangeably in the literature, there remains few distinctions between the two. Gillan, Koch, and Starks (2021) opine that while ESG exclusively takes the ‘governance’ activities, in addition to the environmental and social practices, of corporations into consideration, CSR mainly focuses on the ‘environmental’ and ‘social’ aspects of corporate responsibility, using governance-related practices implicitly as they relate to the other two dimensions. Another difference may be in terms of the purpose or applicability of the two concepts. While CSR offers an idea about a corporation’s sustainability framework, ESG is more likely to be the outcomes of a corporation’s sustainable practices, which are useful to the investors. According to Forbes, ‘While CSR holds businesses accountable for their social commitments in a qualitative manner, ESG helps measure or quantify such social efforts’. (https://www.forbes.com/sites/forbesbusinesscouncil/2021/09/23/three-reasons-why-csr-and-esg-matter-to-businesses/)

8 Formerly, Thomson Reuters Financial & Risk.

9 Formerly, BankScope database of global public and private banks.

10 The Refinitiv ESG data has many missing observations which is why the number of observations in the regressions have been reduced. After dropping the missing ESG observations, the final number of observations comes down to 1,135.

11 The overall EPU index score is calculated as a weighted average of the component-wise scores: [(1/2) * news-based uncertainty] + [(1/6) * (federal/state/local purchases disagreement measure + CPI forecast disagreement measure + tax code expiration index)]. For details, visit: https://www.policyuncertainty.com/us_monthly.html.

12 For details, visit: https://ustr.gov/countries-regions