Periodic Reporting for period 1 - SUSBANK (Environmental Sustainability Engagement of Banks and Systemic Risk)
Reporting period: 2020-10-01 to 2022-09-30
The need for a more socially and environmentally sustainable financial system has never been more crucial than it is at present. Prior studies have considered corporate social responsibility (CSR) as a vital vehicle for achieving sustainable development of the business and the economy as CSR can contribute in several ways. Firms implementing CSR are more profitable due to external factors like enhanced reputation, added market flexibility, and internal factors like innovations; which would lead to sustainable growth. CSR covers six important dimensions –reporting, business ethics and product responsibility, climate and environmental issues, labour issues, community issues, and corporate governance. However, out of those dimensions, presently climate and environmental issues have come out as the single prevalent negative externality of modern times. Experts and policymakers opine those environmental damages are significant threats to financial stability as two types of risk may emerge, namely - transitional risk (due to adjustment process towards a lower-carbon economy), and physical risk (property damages or trade disruption). Further, financing environmentally risky projects can be harmful to a bank’s reputation, which can lead to damage to financial performance, and also to the long-term growth of the bank. Further, as the banks are strongly interlinked; reputation, earnings, and growth have systemic value, and thus any adverse event could severely affect the banking system as a whole through spillover effects. In addition, incentives for short-termism (e.g. CEO compensation) are strongly connected with excessive risk-taking in banks including anti-environmental project financing. Thus, environmental damages could affect the safety and soundness of banks, and also financial stability, and thus increase the systemic risk. Hence, economic activities and welfare suffer greatly.
Furthermore, macroprudential tools have a substantial impact on the systemic risk of banking systems. Consistent with United Nations Environment Programme (UNEP) recommendations to tackle adverse environmental issues, the High-level Expert Group (HLEG) on sustainable finance (established by the European Commission) has put forward the concept of a ‘climate-related financial disclosure’ or a ‘brown-penalising factor’ on banks’ capital requirements. Thus, so far environmental sustainability issues have not yet become a systematic, structured, and integral part of the banking business models and strategies. To strengthen the recommendations of the UNEP, HLEG, and CSIL & UNEP FI , this research has aimed to find empirical support for the explicit acknowledgment and inclusion of environmental risk as an emerging source of systemic risk in the banking system. In attempting so, this research has revealed the impact of the environmental sustainability engagement of banks on four key areas, namely, (1) reputation, (2) earnings quality and growth; (3) incentives for short-termism (e.g. CEO compensation), and (4) systemic risk.
Furthermore, macroprudential tools have a substantial impact on the systemic risk of banking systems. Consistent with United Nations Environment Programme (UNEP) recommendations to tackle adverse environmental issues, the High-level Expert Group (HLEG) on sustainable finance (established by the European Commission) has put forward the concept of a ‘climate-related financial disclosure’ or a ‘brown-penalising factor’ on banks’ capital requirements. Thus, so far environmental sustainability issues have not yet become a systematic, structured, and integral part of the banking business models and strategies. To strengthen the recommendations of the UNEP, HLEG, and CSIL & UNEP FI , this research has aimed to find empirical support for the explicit acknowledgment and inclusion of environmental risk as an emerging source of systemic risk in the banking system. In attempting so, this research has revealed the impact of the environmental sustainability engagement of banks on four key areas, namely, (1) reputation, (2) earnings quality and growth; (3) incentives for short-termism (e.g. CEO compensation), and (4) systemic risk.
The research is carried out to address whether and to what extent the environmental sustainability risk of banks contributes to the systemic risk. In broad, this research attempts to investigate the impact of environmental sustainability engagement (ESE) of banks on their reputation, earnings quality, long-term growth, and CEO compensation which could lessen systemic risk. From all the selected perspectives, namely, reputation, earnings quality, long-term growth, CEO compensation, and systemic risk, the empirical results turned with vital indications.
Based on the econometrc analysis based on broad dataset of 1483 banks from worldwide 88 countries, the empirical investigation confirms that environmental engagement could certainly create a positive impact on banks’ reputation and systemic risk. However, earning quality and growth might be hampered as any green transition requires the cost-ineffective use of scares resources. However, from the stability context of view environmental engagement has to be patricides more as it could impact significantly towards the minimisation of systemic risk and thereby would contribute more to reducing financial and economic instability. Also as expected, EU banks act differently for four out of five aspects including reputation, long-term growth, earning capacity, and systemic risk.
This research provides significant insights for the policymakers and the supervisors enabling understanding of whether and in what magnitude ESE of banks could affect their stability as well as the systemic risk. Accordingly, it will particularly aid policymakers to set a common regulatory benchmark regarding environmental sustainability issues along with the Basel norms. Since the bank's operational impact is mostly external, ensuring the environmental engagement aspect in their lending business model carries much overall impact compared to their green practice to ensure the green transition. However, since the lending business model is directly related to income generation, and as it is proved to be negatively connected with banks’ environmental practices, more regulatory and macroprudential measures are needed to be initiated instead of voluntary measures like the membership of UNEP FI.
Based on the econometrc analysis based on broad dataset of 1483 banks from worldwide 88 countries, the empirical investigation confirms that environmental engagement could certainly create a positive impact on banks’ reputation and systemic risk. However, earning quality and growth might be hampered as any green transition requires the cost-ineffective use of scares resources. However, from the stability context of view environmental engagement has to be patricides more as it could impact significantly towards the minimisation of systemic risk and thereby would contribute more to reducing financial and economic instability. Also as expected, EU banks act differently for four out of five aspects including reputation, long-term growth, earning capacity, and systemic risk.
This research provides significant insights for the policymakers and the supervisors enabling understanding of whether and in what magnitude ESE of banks could affect their stability as well as the systemic risk. Accordingly, it will particularly aid policymakers to set a common regulatory benchmark regarding environmental sustainability issues along with the Basel norms. Since the bank's operational impact is mostly external, ensuring the environmental engagement aspect in their lending business model carries much overall impact compared to their green practice to ensure the green transition. However, since the lending business model is directly related to income generation, and as it is proved to be negatively connected with banks’ environmental practices, more regulatory and macroprudential measures are needed to be initiated instead of voluntary measures like the membership of UNEP FI.
The MSCA-IF research fellowship has created a great opportunity for the researcher to develop his career in research and academia. Through working on this project, the researcher was contributing to the Bangor Business School research groups relating to Banking, Finance, & Economics specifically covering the area of Decarbonisation, Financial Stability, and Economic Sustainability. In this connection, he is also contributing presently to the Places of Climate Change (PloCC) Research Centre at Bangor University. With the experience from the MSCA-IF research, the researcher managed to start his research network within the UK as well as in the EU area. Collaborative research networks are ongoing with distinguished academics in the UK (University of Birmingham, Heriot-Watt University, and the University of Huddersfield); EU region (Copenhagen Business School, Undine University, Witten/Herdecke University); and scholars in international financial and regulatory bodies (IMF, ECB, and United States Department of the Treasury).
With his experience in this MSCA-IF project, the researcher has got the opportunity to prove his capabilities further in the UK academic environment. Development Bank of Wales (DBW) has recently awarded him a joint project (with Prof Yener Altunbas) related to Welsh SMEs entitled – “Net zero Carbon Policies and SMEs initiatives towards decarbonisation: An overview.” The project work has been started in October 2022. This project will open the avenue to liaising with regional and national research bodies (like Economic Intelligence Wales - EIW) to identify future research requirements and to generate the impact of scholarly activity beyond academia.
After completion of the research dissemination, the researcher is planning to continue his effort in relevant areas of research and looking to create a reputed place in academia. At the same time, he is looking to extend similar projects particularly relevant to the developing country context including his home country Bangladesh. Because, due to the environmental and climate change scenarios, developing countries are affected more than developed countries.
With his experience in this MSCA-IF project, the researcher has got the opportunity to prove his capabilities further in the UK academic environment. Development Bank of Wales (DBW) has recently awarded him a joint project (with Prof Yener Altunbas) related to Welsh SMEs entitled – “Net zero Carbon Policies and SMEs initiatives towards decarbonisation: An overview.” The project work has been started in October 2022. This project will open the avenue to liaising with regional and national research bodies (like Economic Intelligence Wales - EIW) to identify future research requirements and to generate the impact of scholarly activity beyond academia.
After completion of the research dissemination, the researcher is planning to continue his effort in relevant areas of research and looking to create a reputed place in academia. At the same time, he is looking to extend similar projects particularly relevant to the developing country context including his home country Bangladesh. Because, due to the environmental and climate change scenarios, developing countries are affected more than developed countries.