Funding Costs and Liquidity Creation: Does ESG Play Any Role?

ABSTRACT This study examines how banks' funding costs affect liquidity creation and whether environmental, social, and governance (ESG) performance shapes this relationship. Using panel data for 136 U.S. commercial banks from 2005 to 2022, we show that higher funding costs are associated with lower liquidity creation, indicating that more expensive funding constrains banks' capacity to supply liquidity in the economy. We also find that stronger ESG performance is linked to greater liquidity creation. Moreover, ESG performance significantly moderates the funding cost–liquidity creation nexus, consistent with the view that banks with stronger ESG profiles can attract more stable or cheaper deposits, as depositors may accept relatively lower interest rates. These findings remain robust across alternative liquidity‐creation measures and a range of empirical approaches, including random‐effects models, two‐step system GMM, and regression discontinuity designs.