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Lower-rated ESG banks benefit from lower borrowing costs

Increase in a bank's Environmental, Social, and Governance (ESG) score corresponds to a decrease of more than 11% in their bond yields, according to findings from Bank of Italy's analysis on 130 eurozone financial institutions.

Lower-rated ESG banks benefit from lower borrowing costs
Lower-rated ESG banks benefit from lower borrowing costs

Lower-rated ESG banks benefit from lower borrowing costs

The report titled "Are ESG ratings important for banks' funding costs? An empirical investigation" published by Banca d'Italia has shed light on the influence of Environmental, Social, and Governance (ESG) ratings on banks' funding costs.

According to the report, banks with higher ESG ratings face reduced funding costs compared to those with poorer ESG scores. This effect is attributed to increased investor demand for sustainable banks and better risk management related to ESG factors, which lowers the perceived credit risk of these banks.

The report finds that governance (G) is the most relevant ESG factor for banks, as banks that are more attentive to governance face fewer legal disputes and are better managed in crisis situations and regulatory changes. Environment (E) has an impact, but its effect is more contained compared to the other two factors (G and S). Social (S) is also important, given the strong connection between banks and local communities and their role in today's society.

The analysis in the report examines bonds issued by over 130 banks in the Eurozone, including banks located in Italy. The report considers ESG ratings attributed to these banks by three major specialized agencies: MSCI, Refinitiv Eikon, and Morningstar.

The report also highlights an interesting asymmetry in the effects of upgrades and downgrades. The cost of a bank's debt is more persistently sensitive to increases in ESG scores than to decreases. For instance, an increase in a bank's ESG score by MSCI can lead to a decrease in their bond yield spread of up to -11.52%.

The report was authored by Stefano Nobili, Mattia Persico, and Rosario Romeo. The analysis covers a long period, from 2015 to 2022. The key takeaway from this empirical study is the clear linkage between ESG ratings and funding cost advantages for banks with higher ESG scores.

The report also suggests that investors are more ready and decisive in rewarding virtuous banks than in punishing those with deteriorating sustainability policies. This implies that banks with better ESG practices are more attractive to investors in the medium to long term, and they can benefit from cheaper access to capital.

In conclusion, the report by Banca d'Italia provides valuable insights into the impact of ESG ratings on banks' funding costs. The evidence supports the notion that ESG ratings are an important determinant of banks' funding costs in today's markets.

[References] [1] Banca d'Italia. (2023). Are ESG ratings important for banks' funding costs? An empirical investigation. Retrieved from bankaditalia.it [2] European Central Bank. (2022). Macroeconomic conditions and bank funding costs. Retrieved from ecb.europa.eu [3] Financial Stability Board. (2021). ESG and financial stability. Retrieved from fsb.org

  1. The report reveals that an increase in a bank's ESG score, as assessed by agencies such as MSCI, Refinitiv Eikon, and Morningstar, can lead to a decrease in their bond yield spread, potentially indicating that better ESG practices might result in cheaper access to capital.
  2. Given the findings of the report, it appears that investors are more inclined to reward banks with superior ESG practices and are willing to offer them funding cost advantages in the medium to long term, while potentially being more reluctant to penalize those with deteriorating sustainability policies.

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