Does Fossil Fuel Financing Affect Banks’ ESG Ratings?

Abstract

The study was conducted on a sample of 60 of the world’s biggest banks financing the largest fossil fuel entities. The aim is to identify the determinants of ESG ratings of these banks and to determine how relevant their actual credit and investment exposure is to this assessment. The indirect objective is also an examination of whether coal power financing affects ESG ratings. Two logistic regression models have been explored: one dedicated to the identification of high ESG risk banks and the second to predict low ESG risk, which thereafter were combined into one final model. The results indicate that an increase in the Sustainable Development Index (SDI) translates into a decline in the odds of being assigned to the high-risk ESG group relative to the probability of being qualified to the low- or medium-risk ESG group. This study is the first to analyse the impact of actual exposures of the world’s largest banks to the fossil fuels sector on their ESG ratings. The value added is the use of a unique database, the focus on actual rather than declared effects of banks’ policies, and the use of a two-stage logistic regression model construction. The proved relationships are important and of practical relevance to bank managers, regulators, and ESG rating providers. Since the research is conducted on the basis of ESG provided only by one rating agency verification of conclusions with the use of ratings of other agencies, confronting benefits from financing the fossil fuels sector with losses resulting from an increase in the cost of obtaining financing are only selected directions for further research.

Keywords

• bank
• ESG rating
• fossil fuel