SUSBANK · Environmental Sustainability Engagement of Banks and Systemic Risk

The need for more socially and environmentally sustainable financial system has never been more crucial than it is at present. CSR is considered as a vehicle for achieving sustainable development of the business and the economy. Presently out of all CSR dimensions, climate and environmental issues have come out as the single prevalent negative externality. Since banks are the development partners of the rest of the economy, anti-environmental engagement could be harmful for bank reputation, earnings quality, and growth. Further, CEO compensation is strongly allied with excessive risk-taking in banks. Thus, as the banks are strongly interlinked, any adverse event could severely affect the banking system as a whole through spillover effects and thus increase the systemic risk. However, the Basel Committee on Banking Supervision has not yet addressed the environmental issues in its macroprudential regulatory framework. Nonetheless, in line with United Nations Environment Programme (UNEP) recommendations, the High-level Expert Group (HLEG) on sustainable finance (established by the European Commission) has argued to initiate a ‘climate-related financial disclosure’ or a ‘brown-penalising factor’ on banks’ capital requirements to address the environmental risk.To strengthen the UNEP and HLEG arguments, the proposed research aims to find empirical support for the explicit acknowledgment of environmental risk as an emerging source of systemic risk. The proposed research is expecting to contribute in several ways. Firstly, to our knowledge, this is the first effort to investigate the impact of environmental sustainability engagement of banks on their reputation, earnings quality, CEO compensation, long-term growth, and importantly on systemic risk. Secondly, the position of EU banks will be compared with other regional banks on the related issues. Thus, the findings will provide significant insights for the policymakers to set a common environmental regulatory benchmark.