Khóa luận tốt nghiệp Tài chính ngân hàng: Linking ESG and liquidity risk: insights from international banking industry

This paper investigates the impact of environmental, social, and governance ESGperformance on liquidity risk.. The liquidity risk played a significant role in the 2007-2008 global financ

VIETNAM NATIONAL UNIVERSITY UNIVERSITY OF ECONOMICS AND BUSINESS

Faculty of Finance and Banking

GRADUATION THESIS

INSIGHTS FROM INTERNATIONAL BANKING INDUSTRY

SUPERVISOR : MSc Luu Hanh NguyenSTUDENT : Nguyen Thi Mai Trang

CLASS : QH2019E TCNH CLC 2

Hanoi, 2023

I would like to express my heartfelt and most sincere gratitude to MSc Luu Hanh

Nguyen for guiding and supporting me throughout the process of making this thesis

Her suggestions are crucial directions to assist me in completing this thesis Althoughmany efforts have been made to do the research in the most comprehensive way, the

limitations of knowledge and experience unavoidably lead to certain shortcomings To finish

my thesis, I hope to gain more valuable and constructive comments from lecturers

Ha Noi, April 20, 2023

AuthorNguyen Thi Mai Trang

I hereby declare that this thesis is the result of my own research and has not been

published in any other research work The use of results, quoting other people's documents

ensures compliance with regulations The contents of citations and references to documents,books, and information are published in works, journals and websites according to the list ofreferences of the thesis

TABLE OF CONTENTS

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CHAPTER 1: INTRODUCTTION 5+ 5sn St + HE HH HH HH1 1 11.11 111111111111111111111711eTkrrk 7 1.1 Urgency 0ï 2i) 117 7

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LIST OF TABLES

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ESG Environment, Social, Governance

CSR Corporate Social Responsibility

HSBC Hongkong and Shanghai Banking Corporation Limited

This paper investigates the impact of environmental, social, and governance (ESG)performance on liquidity risk This research uses fixed-effect model set comprised of 740banks in 70 countries from 2003 to 2022, I show that higher ESG scores are likely to reduceliquidity risk Banks that prioritize ESG scores are more likely to have a stronger riskmanagement framework in place, which can help mitigate potential liquidity risks Tostrengthen the reliability of the results, this study adopted robustness tests to alternative

variable definitions and address endogeneity concerns and found consistent results Our

finding also all ESG dimensions reduce liquidity risk Furthermore, the empirical evidenceindicates that only banks located in advanced economies reap the benefits of increased ESGscores in terms of reduced risk This paper suggests that policymakers and regulators need

to design and implement frameworks and incentive banks to embrace sustainable financebest practices

Keywords: ESG scores; Liquidity risk; Fixed-Effect model; Advance economies

CHAPTER 1: INTRODUCTION

1.1 Urgency of the topic

With the growing global population and the rising climate change risk, the world iscurrently facing a number of environmental and social issues To address these concerns,strategies and initiatives related to corporate sustainability are important for businessestoday, particularly those whose success is more likely to depend on their sustainabilityinitiatives and practices (Naeem et al., 2022) In recent years, the concept of Environment,Social, and Governance (ESG) is gradually become familiar to the public in practice andacademics used to evaluate sustainability and ethics Furthermore, ESG has grownincreasingly important in the context of sustainable economies, as more investors,companies, and governments realize the need to address environmental and social issues inorder to create a more sustainable future In June 2004, the United Nations Global Compactintroduced the idea of ESG and urged businesses to take into account success in these areaswhile focusing on their core business objectives (Drempetic et al., 2020) Performance ESG

metrics are considered as a crucial element that represents a company's capacity to create

value and carry out successful business initiatives

ESG scores offer a tool to evaluate the opportunities and hazards for businesses in

specific fields through ESG scores Comparing ESG scores enables measuring a firm against

competitors in the same industry or sector and helps companies identify areas where theymay strengthen their sustainability and ethical standards Specifically, investors, managers,and other stakeholders can assess and evaluate company performance based on ESG reports

and ratings (Li et al., 2022) ESG could have an impact on future performance and enterprisevalue, including those that are strategic, operational, reputational, regulatory, and financial

(Ng and Rezaee, 2015) Previous evidence support that higher ESG scores are linked withbetter profitability (Gangi et al., 2019), less individual risk-taking (Neitzert and Petras,2022), and increased satisfaction of both customers and employees (Servaes and Tamayo,2013)

On the other hand, banks have a significant role to play in promoting ESG practices,both through their own operations and through the financing and investment decisions theymake on behalf of their clients First, banks may encourage ESG practices in their ownoperations by putting into practice eco-friendly strategies including lowering their carbonfootprint, cutting back on waste production, and switching to renewable energy sources

Second, by providing them with loans, grants, and other financial incentives to apply ESG

measures, banks can encourage their customers to embrace sustainable practices Therefore,banks can greatly contribute to sustainable activities and future societal demands bydirecting financial flows to sustainable operations (UNEP, 2022) Many banks are nowfocusing on ESG factors as part of their commitment to promoting a sustainable economy.Some banks have also developed specific ESG-related products and services, such as greenbonds, sustainability-linked loans, and impact investing funds, to help their clients meet theirown ESG goals For example, Bank of America, HSBC, and JPMorgan Chase, have started greenbond programs to finance environmentally friendly projects including renewable energy andsustainable infrastructure Meanwhile, Goldman Sachs, Morgan Stanley, have formed impactinvesting funds that focus on issues as sustainable agriculture, climate change Therefore,banks are also taking steps to reduce their own environmental impact by adoptingsustainable practices in their operations By promoting sustainable finance and investing,banks can support environmentally and socially responsible businesses while mitigatingpotential risks Through using ESG criteria in their risk assessment and management process

to help identify potential risks and take measures to mitigate them

On the other hand, Silicon Valley Bank (SVB) collapsed in March 2023 because of

without not having efficient liquidity risk management and the capability to anticipate

unfavorable market fluctuations while experiencing rapid growth in short-term finance

Therefore, risk management is critical to the success of banks, as it helps to identify potential

threats and minimize the impact of unexpected events Each bank adopts different riskmanagement strategies that are measured by market risk, operational risk, credit risk, andliquidity risk (Permatasari, 2020) Moreover, as demonstrated by Diamond and Dybvig(1983), banks face enormous risk while creating liquidity, despite is fundamental function ofbanks The liquidity risk played a significant role in the 2007-2008 global financial crisis,

which led to the bankruptcy of several banks and financial institutions During the crisis,

many banks had invested heavily in mortgage-backed securities and other complex financial

instruments, which were difficult to value and sell in the market As investors became

increasingly concerned about the ability of banks to meet their obligations, they began towithdraw their funds, creating a liquidity crisis Besides, banks with higher liquidity risk hadweaker stock performance, significantly reduced loan production, and higher interest rates

on deposits (Beltrati and Stul., 2012; Bai et al., 2018)

Hence, ESG considerations are becoming increasingly important for banks' risk

management strategies (Li et al., 2022) By incorporating ESG into their risk managementframeworks, banks can better identify and mitigate potential risks, furthermore, make use

of new chances to apply sustainability and ethical business practices (Atif and Ali, 2021).Additionally, ESG factors can lower credit risk by providing additional information aboutborrowers’ creditworthiness Banks can more accurately evaluate the physical andreputational risks associated with lending to specific companies or projects Stronggovernance structures can also indicate a lower risk of mismanagement and fraud, which canlessen credit risk (Heniz et al., 2019) Additionally, ESG can also help lower operational risk,which refers to risk from ineffective internal procedures, people, or systems or from externalevents (Li et al., 2022) Finally, ESG can assist in lowering market risk, which refers to therisk of losses due to changes in market conditions Banks can more effectively comprehendand control market risks by taking into account the potential effects of environmental andsocial elements on markets (Sassen et al., 2016) Thus, some literature focuses on the impact

of higher ESG scores reduce credit risk (Henisz and McGlinch., 2019), while others decreaseoperational risk (Galletta et al., 2022), and reduce market risk (Sassen et al., 2016)

However, the research on the impact of ESG affects liquidity risk still limited Liquidityrisk of a bank is the likelihood that customers’ demand for cash withdrawals exceeds a bank'ssupply of cash The risk intensifies if banks face difficulties either in borrowing funds at areasonable cost or selling an asset for its present value to meet liquidity needs (Diamond andRajan, 2001) Overall, the 2007-2008 financial crisis demonstrated the importance ofliquidity risk management for banks and highlighted the potentially devastatingconsequences of a liquidity crisis It also led to significant regulatory changes aimed atimproving liquidity risk management and reducing the risk of future crises Therefore, in thispaper, I examine the role of ESG scores on liquidity risk from international banks

1.2 Research Objectives and Questions

Overall, to contribute to the body of literature, this study supports ESG scores inrelation to banks’s liquidity risk at income level Because the research on the relationshipbetween ESG (Environment, Social and Governance) and liquidity risk in banks acrosscountries is an important topic in the field of finance and banking ESG has become asignificant factor in investment decisions and other financial decisions In addition, liquidityrisk in banks can have a serious impact on the bank's business operations, causing harm to

customers and the community Understanding and evaluating the impact of ESG on liquidity

risk in banks across countries will help bank managers make better decisions and ensure thesustainability of the bank in the future

1.3 Research Scopes and Methodologies

Motivated by the research question, this study utilizes data from a cross-nationalsample of listed banks for the 2003 - 2022 period in 70 countries from Refinitiv, through thefixed-effect method In June 2004, The United Nations Global Compact introduced theconcept of ESG and urged businesses to take into account success in these areas whilefocusing on their core business objectives The sample consists of 14,800 bank-yearobservations from 740 banks globally having ESG scores in Refinitiv database, I documentthat a higher ESG is significantly associated with lower liquidity risk To put it differently,this study constructs two measures capturing the ratio liquidity risk (Saif-Alyousfi et al.,2023; Safiullah and Shamsuddin., 2018)

1.4 Contribution of research

Consequently, this study contributes to the literature in the following ways First, Icontribute to the body of literature examining the impact of ESG on risk management ESGhelps banks improve their risk management practices, reduce financial losses, and enhancetheir overall financial stability Previous literature focuses on the impact of higher ESG ondecreasing credit risk (Henisz and McGlinch., 2019), while others concentrate on reducingoperational risk (Galletta et al., 2022), and decrease market risk (Sassen et al., 2016).However, the impact of ESG on liquidity risk is still limited

Second, my results evaluate the value that ESG adds to a bank using a distinctperspective that breaks down the environmental (E), social (S), and governance (G) pillarsfollowing Saif-Alyousfi et al., (2023); Bilyay-Edogan et al., (2023); Deng et al., (2022); Apergis

et al., (2022) More specifically, I assess how each of three pillars impacts reducing a bank’s

liquidity risk This study finds that higher E scores may be better positioned to manage

environmental risks, such as climate change, that could impact their operations and financialperformance Moreover, banks with higher S scores prioritize worker health and safety may

be more likely to reduce disruptions that could impact liquidity Additionally, banks withhigher G scores such as transparent financial reporting and strong risk management process,may be less likely to experience financial reporting

Third, this study divides panel data into countries’ income levels and assess its impact

on the relationship of ESG with bank liquidity risk This study finds that only advancedeconomies reduce liquidity risk, meanwhile, bank headquarter in emerging economies werefound to be statistically insignificant with liquidity risk However, low-income developingcountries may not prioritize ESG considerations in their investment and business practices.Furthermore, this research uses the robustness test to support my result of the relationshipbetween ESG and liquidity risk as no fixed effects, alternative measurement liquidity risk,alternative clustering, and additional macro data on GDP growth and labour force

Finally, policymakers can also benefit from a better understanding of the impact ofESG on bank risk management decisions, as it can help them design and implement effectivepolicies that promote sustainable economic growth according to income levels Overall, thestudy highlights the importance of considering the impact of ESG on bank risk managementdecisions and the need for ESG scores that balance environmental, social and governanceobjectives with economic growth

1.5 Structure of the study

The rest of this study proceeds as follows Chapter 1 introduces the topic and purpose

of this study Chapter 2 examines the literature review and develops hypotheses focusing onthe impact of ESG on liquidity risk In Chapter 3 this study describes a detailed the researchmethod process, including data collection and analysis data and the research design of thestudy In Chapter 4 this research detail the main result, robustness tests and additionalanalysis method about the impact of ESG on liquidity risk of banks having ESG scores Thisstudy provides my conclusion and discusses implications of future development direction in

Chapter 5 Finally, references list documents to present the research

CHAPTER 2: LITERATURE REVIEW

2.1 Institutional background

2.1.1 Environment, Social, Governance

There is a growing amount of interest in how much business activity contributes to

or detracts from social well-being ESG or Corporate Social Responsibility (CSR) are commonterms used to describe corporate behavior in this area Due to rising customer demand andregulatory demands, ESG and CSR have gained more attention in recent years (Tsang et al.,2023) To boost their reputation and obtain a competitive edge, firms have started

concentrating on incorporating ESG/CSR into various facets of theirs The fact that 300

mutual funds attracted new assets with ESG mandates earned a combined $20 billion in

investments in 2019 alone highlights the enthusiasm of investors in ESG/CSR net flows,which were four times higher than in 2018 (Gillan et al., 2021) Moreover, stakeholders are

putting growing pressure on businesses to adopt more sustainable practices, have smaller

negative effects on society and the environment, and to disclose sustainability-relatedinformation in more detail through effective disclosure procedures (Eliwa et al., 2019)

ESG incorporation is becoming more popular thought to improve a managedportfolio's performance by boosting returns and lowering portfolio risk (Broadstock et al.,2020) Additionally, firm’s performance on ESG measures is thought to be a crucial indicator

of their capacity to create value and carry out successful business strategies (Apergis et al.,

2022) The mainstream interest among asset managers in ESG investing has increased In the

largest markets in 2019, ESG focused portfolio capitalization exceeded US$30 trillion

(Broadstock et al., 2020) ESG investing is important to investors through ethical investmentbehaviors are actively encouraged by an emphasis on ESG investing ESG not only has gainedincreasing attention in the past decade from various customers, also employees, publicinterest groups, and government regulators As it implies, ESG refers to how corporations

and investors integrate environmental, social, and governance concerns into their business

models Meanwhile, a growing number of US corporations are assessing, disclosing, and

managing sustainability risks and opportunities in response to the UN Sustainable

Development Goals (SDGs) and investors’ increased attention to investing (Buallay et al.,2021)

The ESG framework includes three pillars: environmental, social, and governance(Sassen et al., 2016) Environmental factors take into account an organization's overall

environmental impact as well as any possibilities or hazards that may arise as a result ofenvironmental problems like climate change and actions to conserve natural resources Theenvironmental pillar (E) covers a wide range of topics, such as how an organization affectsthe environment, which may include its carbon footprint; the use of toxic chemicals in itsmanufacturing processes; and its supply chain sustainability initiatives The social pillar (S)evaluates how an organization contributes to society at large as well as in its immediateneighborhood Social pillar includes hiring procedures, diversity in the executive suite andworkforce as a whole, gender equality, and racial diversity Furthermore, the social pillar

even considers a company’s efforts to promote social justice outside of its narrow business

niche The governance pillar (G) evaluates how a company's management and boardinfluence transformation This component focuses on aspects of executive compensation,leadership diversity, and how well the leadership responds to and engages with

shareholders

Besides, firms use ESG scores to evaluate a company's performance in relation toenvironmental, social, and governance factors ESG Scores from Refinitiv are designed totransparently and objectively assess a company's relative ESG performance, commitment,and effectiveness across 10 main themes (emissions, environmental product innovation,human rights, shareholders, etc.) based on publicly-reported data The category scores arecombined into three pillar scores: corporate governance, social responsibility, and the

environment The ESG pillar score is a relative total of the industry-specific environmental

and social category weights The weights for governance are constant across all sectors Thepillar weights are normalized to percentages from 0 to 100

According to Broadstock et al (2020), higher E scores that a company must performeffectively in areas including environmental management system certification, waterconservation, energy efficiency, waste gas emission reductions, and minimizing accidental

waste and spills Moreover, long-term environmental hazards are reduced, and a lean and

versatile organization Meanwhile, strong S scores indicate consistent achievement in avariety of areas, including managing social controversies, community participation,employee benefits, and supply chain management Therefore, good performance in the Sdimension is correlated with a relatively larger commitment to and pressure to keepemployees during the crisis to choose the morally right course of action rather than firingstaff to deal with financial demands Additionally, for a bank to receive a high G score, they

must have demonstrated strong performance in a number of areas, such as policy, foreign

tax obligations, board diversity, auditor independence, whistleblowing, and managingnegative governance-related incidents Strong success in these areas should contribute to acompany's overall financial stability

By having clear ESG performance and enhanced policies around ESG, firms can reducerisk by avoiding companies exposed to environmental litigation, labor unrest, shareholderrevolts, or other events that could harm their reputation and financial outcomes(Bissoondoyal-Bheenick et al., 2023) Companies that do not appropriately manageenvironmental risks may be more exposed to legal or regulatory actions, which could lead toreputational damage and financial losses Similarly to this, weak labor practices may putbusinesses at risk for employee turnover, labor unrest, and decreased productivity.Furthermore, fraud, corruption, and shareholder agitation may be more common in

businesses with poor governance actions By emphasizing and incorporating ESG

considerations into their risk management and investment decision-making processes, firmscan mitigate these types of risks On the other hand, sustainability funds can generate returnsthat are comparable to or superior to those of regular funds, a company that providesinvestment research, management, and technology Additionally, ESG assists businesses infinding and keeping high-quality employees to give them a feeling of purpose can raise theirmotivation at work and their overall productivity Therefore, ESG can reduce expenses,operating costs, energy costs, and other expenditures can be cut over time when ESG

principles are integrated into an organization's structure

Previous studies report that has shown that investing and doing business according

to ESG standards can bring about positive financial returns and social impact The GlobalSustainable Investment Alliance (2022) reported that the total amount of sustainableinvestments worldwide has increased from USD 13.3 trillion in 2012 to USD 35.3 trillion in

2020, equivalent to a growth of more than 15% per year The growing ESG assets under

management, which are projected to total $30 trillion in 2019, $35 trillion in 2020, and more than $50 trillion by 2025, serve as proof of this As a result, they account for more than a

third of the anticipated $140.5 trillion (Apergis et al., 2022) Moreover, the specific ESG

issues that banks prioritize may vary depending on the income levels of the countries theyoperate in According to Andries and Sprincean et al., (2023), they show that only large banks

and those from advanced countries benefit from transparency on the dissemination of ESG

company's stock will perform well The success of businesses and ESG funds alike might

suffer from changes in market conditions, business trends, and the general economy inaddition to other internal issues

In the banking industry, ESG factors are becoming increasingly important and are

being integrated into risk management, lending, and investment decision-making processes

(Li et al., 2022) By incorporating ESG into their risk management frameworks, banks canbetter identify and mitigate potential risks, furthermore, make use of new chances to applysustainability and ethical business practices Banks may build more effective risk mitigationstrategies and can gain a more comprehensive view of the risks they face and develop more

effective risk mitigation strategies Furthermore, banks that prioritize ESG considerations

are often viewed more positively by customers, employees, and investors, which can assistlower reputational risk in the event of negative ESG related events By demonstrating a

commitment to ESG considerations, banks may be able to attract new customers and

partners who interest in sustainability and social responsibility Finally, incorporating ESGconsiderations into risk management practices can help banks in lowering risk, enhancetheir reputation, and better meet stakeholder expectations, which will ultimately result inthe development of long-term value

2.1.2 Liquidity risk

The banking industry is not the only one that benefits from risk management, thisindustry benefits more from it because of the serious financial and economic repercussions

of bank failure During operation, banks are exposed to various types of risks, such as credit

risk, liquidity risk, interest rate risk, and operational risk (Ben Abdesslem et al., 2022) Theeffectiveness of bank risk management methods has been questioned in the wake of the 2007financial crisis (Azmi et al., 2021) The challenge of safeguarding against financial instability

has become even more important after the global financial crisis of 2007-2008, which

resulted in significant losses around the globe (Mamatzakis & Bermpei, 2014)

Since the global financial crisis, Silicon Valley Bank's collapse is the biggest bankfailure in the United States The bank’s vulnerability is due to the bank's high percentage ofuninsured deposits and the number of deposits placed in hold-to-maturity securities.Therefore, financial crisis of 2008 of Lehman Brothers, one of the world's largest investmentbanks and SVB’s collapse highlighted the crucial importance of liquidity risk management inbanks During the financial crisis, many banks experienced liquidity problems, as theinterbank lending market froze up and banks were unable to access funding This led toseveral high-profile bank failures and required significant government interventions toprevent a wider financial collapse The danger that a business or person will not have enoughmoney to meet their financial commitments or pay their debts on time is known as liquidity

risk The risk develops when a corporation is unable to buy or sell an investment in exchange

for cash quickly enough to satisfy its debts Liquidity is the simplicity with which an asset can

be turned into cash without adversely influencing its market price As a result, institutionsmust adhere to high compliance standards and undergo stress tests to assess their financialsoundness

As while creating liquidity is a fundamental role of banks, Diamond and Dybvig(1983) demonstrate that it also represents a sizable risk for those institutions The primarycrisis of 2007-2009 shows how significant liquidity risk may be Liquidity risk can arise from

a variety of factors, including changes in market conditions, unexpected changes in cashflows, or unanticipated events that require the bank to make large payments Banks manageliquidity risk by maintaining sufficient levels of liquid assets, such as cash and governmentsecurities, that can be easily sold or pledged as collateral in times of stress They also usevarious funding sources, such as deposits, interbank borrowing, and access to central bank

facilities, to ensure they have adequate liquidity Financial institutions rely heavily on

borrowed funds, thus it is frequently examined to see if they can repay their debts without

suffering significant losses that could be catastrophic

However, even with these measures in place, banks can still face liquidity risk if theyexperience unexpected changes in their funding or cash flow positions In extreme cases, abank may become insolvent if it cannot meet its obligations, leading to potential financialinstability and systemic risk When banks face liquidity risks, their business activities may

be disrupted and can cause serious financial problems In particular, delayed or defaulted

loans can lead to a decline in the bank's reputation and hinder its ability to borrow funds.Therefore, liquidity risk management is crucial for banks as it helps to ensure that they havesufficient funds available to meet their financial obligations and operational needs, especiallyduring times of financial stress or market disruptions By effectively managing liquidity risks,banks can reduce the likelihood of financial instability, maintain their reputation andcredibility, and avoid potential regulatory penalties Effective liquidity risk management alsoenables banks to take advantage of investment opportunities and support economic growth

In summary, liquidity risk management is essential for the long-term viability and success ofbanks

On the other hand, regulators require banks to maintain minimum levels of liquidityand to have adequate contingency plans in place to manage liquidity risk Firstly, banks arealso subject to regular stress tests to assess their ability to withstand a range of adversescenarios Secondly, banks diversify the sources of funding and investments of the bank inorder to minimize concentration risks Thirdly, banks need continuously monitor andevaluate liquidity risks to ensure that liquidity risk management strategies are effectivelyimplemented Finally, banks should have contingency plans to deal with potential risks andensure their liquidity in worst-case scenarios also manage proper cash flow management topay customers when needed, while also ensuring the bank’s liquidity

2.2 Empirical evidence

Banks and other financial organizations are increasingly using a set of criteria known

as ESG to evaluate the sustainability and moral implications of their investments andbusiness operations Banks can utilize ESG scores and analysis to evaluate the governancepractices of their clients and partners as well as to screen possible investments forenvironmental and social hazards

ESG factors may encourage businesses to innovate and create new goods and services

that cater to socially conscious customers Corporate innovation can be encouraged by ESGperformance and ESG rating events with high financial investment behavior (Li et al., 2022)

This paper empirically investigates the mechanism of ESG rating events affecting corporate

innovation of listed businesses using Chinese A-share non-financial listed companies from

2009 to 2020 as research samples The empirical findings of this study demonstrate thatbusiness innovation inputs and outputs are significantly positively impacted by ESG rating

events under high financial investment behavior On the other hand, Bilay-Erdogan et al.,(2023) given that dividends are the most common form of payout, it is crucial to examinehow ESG influences wealth distribution through dividend policy They use a panel data setcomprised of 1094 listed non-financial companies from 21 different European nationsbetween 2002 and 2019 They demonstrate that businesses with better ESG performanceare more likely to increase dividend payments ESG activities result in more effectivemanagement, better asset allocation, and better relationships with stakeholders, as well aslower transaction costs, an improved competitive advantage, and fewer cash flow shocks

during adverse events.

Additionally, incorporating ESG factors into bank operations can promote betterperformance, improve customer engagement, reduce funding costs, and increase cash flowand efficiency Azmi et al., (2021) document the relationship between ESG and bank value.They find that ESG activity expansion enhances bank performance Their sample includes

251 banks over the period 2011-2017 from 44 emerging economies They argue that byenhancing bank transparency above and beyond what regulators mandate, ESG engagementcould provide banks in emerging nations with the biggest benefits Their findings suggestthat policymakers might find it useful to further investigate the benefits that specific ESG

activities offer emerging market banks and their communities Moreover, Andries and

Sprincean., (2023) shows that banks gain from incorporating ESG practices into financial

decisions, benefiting lower cost raising interest-bearing liabilities, as well as reduced costs

of attracting deposit Finally, Liu et al., 2023 shows that bank’s ESG performance enhancesits loan quality and provides evidence of the importance of all three pillars of ESG

On the other hand, considering that ESG operations have become a crucial part oforganizations may face lower risks related to environmental, social, and governance (Wang

et al., 2023) Apergis et al., (2022) point out that ESG is a tool and a framework that can

expand the risk knowledge for investors and increase the effectiveness of their investing

choices They find that low ESG scores are seen as a risk factor for businesses because theyexpose them to environmental, social, and corporate responsibilities that eventually raisetheir default risk Furthermore, businesses with better ESG performance earn higher profitsand experience less income volatility Sassen et al., (2016) find the impact of Corporate SocialPerformance (CSP) measured by aggregated ESG scores on total systematic and idiosyncraticrisk They used a large number of control variables to construct fixed effects regressions at

the firm level with cluster-robust standard errors They found that the higher the aggregated

ESG scores, the lower the total and idiosyncratic risk Social performance has a significantlynegative effect on all three risk measures In regard to managerial implications, their findingsshow that risk can be reduced by environmentally conscious businesses investing in bothsocial and environmental performance

Moreover, ESG enhances capacity to predict the proper identification of distress(Citterio and King., 2022) They use a sample of 362 commercial banks headquartered in the

US and EU-28 member state from 2012 to 2019 ESG, in particular, significantly lowers the

possibility of misclassifying defaulted banks as healthy They estimate using six various

methodologies, such as conventional statistical techniques, machine learning approaches,and ensemble methods, has implications for both the research on default prediction andpractical consequences by banking sector supervisors Furthermore, Galleta et al., (2022)used a global sample of banks operating in 35 countries from 2011 to 2020 They discoverthat operational risk is negatively correlated with bank ESG combined score Banks canlower the amount of capital they absorb for operational risk by using ESG core Additionally,they also find evidence that the lagged ESG composite score and bank operational risk arerelated ESG reduces the capital requirements for problematic operational assets, which has

a substantial economic influence on operational risk

market risk (Sassen et al., 2016) However, the research of ESG on liquidity risk is limited

To fill this research gap, this study is the first to assess the impact of ESG on liquidity

risk in international banks Therefore, banks may build more effective risk mitigation

strategies and can gain a more comprehensive view of the risks they face and develop moreeffective risk mitigation strategies Furthermore, this study is also the first demonstrate thatESG factors is different in advanced economies and emerging market economies affect toliquidity risk On the other hand, this study finds that one major challenge in low-income

developing countries is the lack regulatory frameworks and incentives to promote ESG

factors

2.4 Theoretical framework and developing hypothesis

Previous research demonstrate that a company's stakeholder orientation and itsperformance in terms of ESG related to higher profitability (Gang et al., 2019), increasedemployee and consumer satisfaction (Servaes and Tamayo., 2013) Additionally, a literatureprovides evidence that a bank's strong performance across all three ESG evaluation pillarslowers its ratio of non-performing loans (Liu et al., 2023)

On the other hand, stakeholder theory can be used to support the claim that low

financial risk is linked to high levels of CSP (Sassen et al., 2016) By considering the interests

of all stakeholders, companies can build a positive reputation and earn the trust of theircustomers and other stakeholders through sustainable investment therefore reducing therisk involved firms The main goal of stakeholder theory is to produce long-term value for allstakeholders, rather than just maximizing shareholder value According to the theory, firmscan develop sustainable competitive advantages, strengthen stakeholder relationships, andimprove stronger relationships with stakeholders, and their reputation and socialresponsibility

Additionally, sustainability theory encourages organizations to take proactive

measures to mitigate risks related to ESG factors For instance, by reducing greenhouse gas

emissions, improving water efficiency, or promoting social responsibility, organizations canreduce their exposure to environmental and social risks, and enhance their long-term

resilience Furthermore, sustainability theory promotes transparency and accountability,which can reduce reputational risks and build stakeholder trust By improving ESGreporting, organizations can better communicate their risk exposure and managementpractices, which can help investors and other stakeholders make informed decisions Finally,

banks that prioritize ESG factors may also see increased operational efficiency by reducing

energy consumption or waste, banks can reduce costs and improve profitability

Additionally, banks that invest in technology to improve ESG reporting can reduce the cost

and complexity of compliance

Higher ESG scores are associated with reduced default risk through increasedprofitability and reduced performance variability and cost of debt (Atif and Ali., 2021; Li etal., 2022) On the other hand, banks with higher ESG scores tend to have lower risk profiles,

as they have better risk management practices, stronger customer engagement, lower

financing costs, and increased operational efficiency Additionally, investors and otherstakeholders frequently have a more positive opinion of companies with high ESGperformance, which can enhance their access to finance and lessen the chance of riskmanagement In case bank has a high default risk, it may lose the faith of its creditors andinvestors, which could result in a run on the bank and a lack of liquidity Then they have tosell off assets fast to offset its losses from failed loans, which might potentially contribute to

a liquidity crisis (Imbierowicz and Rauch., 2013) Hence, ESG factors can indeed help reduce

default risk by providing greater insight into a company's long-term prospects and risks, and

by promoting sustainable practices that enhance the company's ability to manage risks andgenerate value over the long term

For this reason, higher ESG scores is likely to decrease liquidity risk by improving riskmanagement, strengthening customer engagement, increasing bank performance.Therefore, this study hypothesizes as follows:

H1: Higher ESG scores will constrain liquidity risk global banks