The role of Environmental, Social, and Governance (ESG) in predicting bank financial distress

Finance Research Letters, Volume 51, January 2023, 103411

AlbertoCitterioaTimothyKingb

a Department of Economics, University of Insubria, Via Monte Generoso, 71, 21100 Varese VA, Italy
b School of Accounting and Finance, University of Vaasa, Wolffintie 34, FI-65200 Vaasa PL 700,Vaasa, 65101 Finland

Received 20 July 2022, Revised 10 October 2022, Accepted 10 October 2022, Available online 12 October 2022, Version of Record 17 October 2022.

ABSTRACT

We analyze the predictive power of Environmental, Social, and Governance (ESG) indicators to forecast bank financial distress using a sample of 362 commercial banks headquartered in the US and EU-28 members states from 2012 to 2019. Our results demonstrate that ESG improves the predictive capability of our model to correctly identify distress. Notably, ESG strongly reduces the likelihood of misclassifying distressed/defaulted banks as healthy. Our model, which we estimate using six alternative approaches, including traditional statistical techniques, machine learning approaches, and ensemble methods, has implications for both practical implications by banking sector supervisors, as well as literature on default prediction.