The impact of country risk factors on bank’s earnings volatility in emerging Europe

Purpose This paper aims to empirically investigate how a country’s risk factors, including environmental, social and governance (ESG) risk and sovereign risks, influence the earnings volatility of banks in 19 emerging European countries between 2000 and 2023. Design/methodology/approach The study applied Panel-Corrected Standard Errors (PCSE) to address heteroskedasticity and cross-sectional dependence. An IV-GMM model was then used to correct for error correlation and handle endogeneity and other flexible error structures. In addition, the Systems Quantile Regression model was used to examine the relationship between earnings volatility (EVOL) and independent variables across various quantiles, offering deeper insights into heteroscedasticity. Findings The study finds an asymmetric effect of the impact of sovereign risk revisions on the financial performance of Emerging Europe banks was found. In fact, while such revisions generally do not have a significant effect, they may have a notable impact under certain conditions or in specific subgroups, such as EU candidate countries. This suggests that upgrades and downgrades might influence financial performance differently, or their effects may vary depending on regional or bank-specific industrial variables. Practical implications Emerging European countries should adopt sophisticated risk management frameworks that integrate sovereign and ESG risks. ESG factors should be included in financial risk assessments, and governments should focus on improving condition of a sovereign’s environmental sustainability, the resilience of their social systems and the effectiveness of their governance. Originality/value This research offers a comprehensive analysis of sovereign and ESG risks on earnings volatility in emerging European banks, highlighting asymmetric effects of sovereign risk revisions and providing policy insights to strengthen financial stability and resilience.