Business model and ESG pillars: The impacts on banking default risk

The recent banks' failures have highlighted the importance of improving banking sector supervision, empha-sizing the need to adopt a holistic approach to risk assessment based on an evaluation of a bank's business model (BBM) that combines financial (e.g., bank's balance data) and non-financial information (e.g., bank's ESG per-formance). In this study, we explore the joint effect of BBM and their environmental (ENV), social (SOC), and governance (GOV) pillars performance on banks' riskiness profile. The study uses a sample of 639 EU banks from 2013 to 2022 and applied a random effects model. Our findings suggest wholesale and retail banks could mitigate default risk, enhancing their ENV pillar performance. Differently, investment banks are encouraged to improve their governance best practices and structure to take advantage in terms of riskiness reduction. These results remain consistent after a series of robustness tests, including the 2SLS model and the Arellano coefficient esti-mation. Our paper offers practical implications for banking supervisory authorities and practitioners, encour-aging to adopt a diversified ESG investment strategy according to bank-specific business models.

Automated summary

The recent bank failures have shown that improving banking sector supervision is crucial. This study examines the joint effect of a bank's business model and its environmental, social, and governance performance on its risk profile. The findings suggest that different types of banks can mitigate risk by improving specific aspects of their performance.