Exploring the causality relationship between bank’s ESG performance and loan portfolio quality in emerging markets

This study explores the causal relationship between Environmental, Social, and Governance (ESG) performance and loan portfolio quality (LLP) in banks within emerging markets using a Granger causality framework. Analyzing annual data from 153 banks across 12 countries during 2010–2023, the study provides strong evidence of ESG’s predictive power over LLP and key financial indicators, including ROA, NIM, bank size, TIER1 capital adequacy, and GDP growth. Higher ESG scores enhance loan portfolio quality through improved credit risk management, reflecting stronger governance and sustainability-driven operations. ESG also exhibits instantaneous causality, highlighting its immediate impact on loan portfolio quality and financial performance. Conversely, LLP does not Granger-cause ESG but shows instantaneous associations influenced by external factors. These findings emphasize ESG integration as vital for mitigating risk and achieving financial stability in banks. The study advocates proactive ESG adoption in credit risk frameworks and sustainability-incentivizing policies, offering actionable insights for sustainable banking practices.