<scp>ESG</scp> Performance and Capital Costs in Banking: The Moderating Role of Trade Freedom in Sustainable Development

ABSTRACT This paper examines the relationship between Environmental, Social, and Governance (ESG) practices and the weighted average cost of capital (WACC) within the banking sector, utilizing data from 508 banks across 45 countries over the period 2009–2023. The research reveals a non‐linear, inverted U‐shaped relationship between ESG and WACC, which is further moderated by the country's level of trade freedom. Particularly, for developing economies, high levels of trade freedom reshape the original curve, yielding a U‐shaped ESG–WACC relationship. The study enriches the academic discourse around ESG and WACC by challenging the prevailing assumption of linearity while highlighting trade freedom as a critical moderating factor, offering empirical insights into strategic and sustainable ESG integration. The study urges bank managers to pursue ESG adaptively, balancing integration with economic contexts. For policymakers, ESG adoption can be facilitated through taxonomies and incentives to assist banks in the initial costly transition stage. For emerging economies, liberalized, sustainability‐aligned trade policies may be pursued to better incentivize ESG adoption and accelerate the transition to a sustainable financial system that supports inclusive growth and long‐term economic resilience.