Unraveling the Nexus between Sustainable Development, Bank Profitability, and Loan Loss Provisions in Vietnam: A Bayesian Vector Autoregression Perspective

Financial institutions play a crucial role in financing projects and initiatives that promote sustainable development (SD). However, banks are under increasing pressure to align with the United Nations’ SD goals by divesting from high CO₂-emitting industries and reallocating capital toward environmentally responsible investments. While this transition supports long-term sustainability, it can lead to short-term profitability challenges, as SD projects often involve higher risks, regulatory uncertainties, and lower immediate returns compared to traditional business activities. As a result, banks may need to adjust their loan loss provisions (LLP) to account for potential credit risks associated with these investments. This study investigates the impact of supporting SD goals on bank profitability (BP) and LLP in Vietnam from 2008 to 2019. To achieve this, we employ a Bayesian Vector Autoregression (BVAR) model, which is particularly useful in analyzing dynamic relationships, addressing heterogeneous variables, and managing small sample sizes. Our findings indicate that investing in SD projects initially reduces bank profitability due to increased costs and uncertainties, prompting banks to raise LLP. However, in the long run, such investments contribute to financial stability, enhance risk management, and strengthen the bank’s overall reputation. By integrating SD principles into their investment strategies, banks can not only mitigate environmental and social risks but also create long-term value for stakeholders, reinforcing their credibility in an evolving global financial landscape.