Bank Sustainability, Default Risk and Systemic Risk Nexus

Abstract

This article aims to study the theoretical nexus between bank sustainability and bank risk. Bank sustainability can be proxied by ESG scores while bank risk can be gauged by stand-alone risk (default risk) and systemic risk contribution. As per the risk-mitigation view, which has its foundation in stakeholder theory and moral capital theory, bank sustainability, and bank risk are inversely related. Sustainability helps to create moral capital and has a risk-mitigating effect like insurance. On the contrary, as per the over-investment view, which has its foundation in agency theory, the association between bank risk and sustainability is positive because of management entrenchment, i.e., managers invest in sustainability for their goodwill or benefits and not for the shareholders’ value maximization. If we look at the relationship between bank risk and ESG pillars individually, we find a negative association in the case of environmental and social pillars, while both positive and negative associations (i.e., mixed results) are found in the case of the governance pillar.