ESG and bank’s cost of capital: A comparative non-linear analysis of developed and developing economies

Abstract

This study examines the non-linear relationship between the banks’ ESG practices and its cost of capital (WACC) over a 15-year period from 2009 to 2023. The study reveals that within the global context, ESG adoption initially reduces the WACC of banks by building stakeholder confidence, enhancing risk management capabilities, and facilitating access to sustainable financing. Yet, once a certain threshold is surpassed, overinvestment in ESG initiatives results in diminishing returns, driving up WACC due to elevated compliance expenses, operational inefficiencies, and possible agency conflicts. This finding is particularly true for developed economies, where the association between ESG and WACC follows a U-shaped curve, indicating that initial ESG adoption lowers WACC, but as investment becomes excessive, banks face heightened capital costs. For developing economies, however, the ESG-WACC association follows an inverted U-shaped pattern, where early ESG investments drive up banks’ WACC and later reduces it as ESG practices mature and access to global sustainable finance improves. These results highlight the importance of strategic ESG integration, tailored to the specific economic context, to optimize financial outcomes. Our research offers critical insights for banks, policymakers, and investors, underscoring the importance of strategic ESG investments and tailored regulatory measures to harmonize sustainability objectives with financial efficiency