Beyond the disruptions from the 2007–2008 financial crisis, the collapse of the Silicon Valley Bank, and acquisition of Credit Suisse by UBS Group AG in 2023, global banks continue to show weakness in absorbing major on- and off-balance sheet risk exposures. This study focuses on the joint and separate effects of Environmental (E), Social (S), and Governance (G) scores on bank risk captured both by a series of market related risk indices including cost of capital, and both levered and unlevered CAPM betas. Using a sample of U.S. banks over the period 2016 through 2023, banks’ financial and market data are triangulated with the total and composite ESG scores, all obtained from the London Stock Exchange Group (LSEG) database, formerly known as Refinitiv. The main hypotheses predict that (i) investors demand a lower cost of capital from banks with higher ESG scores, and (ii) banks with higher ESG scores are exposed to lower systematic risks captured both by levered and unlevered betas. Overall, we contend that banks with higher ESG scores establish better operational alignment with employees, shareholders, customers, consumers, and communities while exercising greater due diligence by focusing on a pool of environmentally conscientious borrowers .

The paper’s contributions to the literature is twofold. First, unlike previous studies, the focus on cost of capital and systematic risk indices captures the crucial interactions between ESG investment and firm decisions resulting from market imperfections and regulations. Second, empirical adjustments are made to address potential endogeneity problems in the model caused by factors such as reverse causality between ESG investment and risk, omitted variables, and measurement errors using the instrumental variables technique and application of simultaneous equation systems including the Seemingly Unrelated Regression (SUR) and Two Stage Least Square (2SLS) approaches.