The ESG Washing in Banks

Evidence from the Syndicated Loan Market

May 28, 2024Published by Journal of International Money and Finance

Banks with substandard ESG ratings lend to firms with better ratings to conceal their poor sustainability performance and boost their green reputation, according to this paper for the Journal of International Money and Finance. Polluting banks are motivated to engage in this kind of “ESG-washing” as stock markets tend to have a positive reaction to their green loan announcements.

As green finance grows, so too does the number of banks and firms seeking to brand themselves eco-friendly. Yet many fail to make the substantive changes needed to truly transition to a sustainable business model. The authors – Kuo-Jui Huang, Dien Giau Bui, Yuan-Teng Hsu and Chih-Yung Lin – mention a Reuters story which states that instances of greenwashing in finance rose globally by 70% in 2023.

The opaque nature of financial markets encourages banks to prioritise observable, superficial green investments over genuine sustainability efforts, according to the paper. To counter this, the authors advocate for improving comparability, transparency and simplicity in ESG disclosure – steps they argue are crucial to address information asymmetries.

Moreover, they urge regulatory bodies and policymakers to intensify monitoring of ESG-washing to bolster consumer and investor confidence while channelling funds toward truly sustainable companies.

Through regression analysis of a sample of 1999-2016 syndicated loan data, the study investigates how the ESG performance gap between banks and borrowers impacts loan terms as well as market reactions to green loan announcements.

Overall, the analysis shows that banks performing worse in terms of ESG tend to offer preferential lending conditions – with significantly lower loan spreads, longer maturities, fewer covenants and fewer collateral – to firms with relatively higher ESG performance ratings. The authors use data from Refinitiv’s MarketPsych ESG Analytics database to examine the difference in ESG scores between borrowing firms and lending banks.

An increase of one standard deviation in the lender-borrower ESG gap leads to a 9% decrease in loan spreads, equivalent to 11.5 basis point reduction in annual interest rates for this sample. The larger the gap, the greater the effect on spreads. These effects persist even after controlling for loan, bank and firm characteristics like size and profitability.

The results also show a surge in bank stock prices when these loan deals are announced, indicating that banks can successfully divert the market’s attention away from their social responsibility conduct by publicising their green lending. This gives banks performing poorly on ESG an incentive to provide high-profile loans to firms with better ratings rather than invest in their own low-carbon transition.

Finally, the authors examined a sub-sample of high-polluting firms and reveal that banks are especially active in ESG-washing in potentially climate-damaging sectors like cement and electricity production. Investors, in turn, react even more positively to this practice in such high-polluting industries.

The authors suggest that, as these sectors are under more intense and public scrutiny from stakeholders and investors, attempts by banks to gain positive publicity for green lending may be more likely to gain traction.

This page was last updated May 28, 2024

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