ESG, Credit Risk, and Bank Stability: Implications for Financial Performance in GCC Banking Systems

Abstract

The increasing incorporation of environmental, social, and governance (ESG) factors into banking raises significant concerns regarding the impact of sustainability practices on risk and financial performance in emerging markets. The mechanisms and boundary conditions through which ESG affects bank outcomes have received little attention, despite earlier research showing conflicting evidence on the relationship between ESG and performance. Using a moderated-mediated framework that specifically takes bank stability and credit risk into account, this study investigates the relationship between ESG and financial performance in GCC banks. The World Bank provides macroeconomic variables, and Refinitiv provides ESG and financial data using an unbalanced panel of listed GCC banks from 2005 to 2024. In addition to mediation, moderation, and bootstrapped conditional process analyses, STATA 19 estimates fixed-effects panel regressions. The findings indicate a positive correlation between market valuation and bank profitability and ESG performance. More importantly, this relationship is strongly mediated by bank stability, suggesting that ESG improves financial performance mainly by lowering the risk of insolvency. However, in high credit risk situations, ESG's performance-boosting and stabilizing effects diminish, indicating a moderated mediation effect. These results hold up well to different performance metrics and ESG requirements. By offering mechanism-based proof of ESG efficacy in an emerging-market setting, this study adds to the literature on banking and finance. The findings highlight the role of ESG integration in fostering financial stability and sustainable banking performance, which has significant ramifications for regulators and bank managers.

Keywords: ESG Performance; Bank Stability; Credit Risk; Financial Performance; GCC Banks; Moderated Mediation; Sustainable Finance