Do ESG scores affect financial systemic risk? Evidence from European banks and insurers

We investigate whether and how the systemic risk of European banks and insurers is sensitive to the ESG performance of non financial companies. We adopt a market-based approach and measure the former through the delta conditional Value at Risk of the banking and insurance sectors, whereas the latter is given by a series of market indexes built to account for both the overall ESG commitment and the compliance to each single pillar of the ESG paradigm. By analyzing the period January 2016 – July 2022, we observe that a better performance of green and ESG complaint companies, which turns out in a raise in the level of the respective indexes, reduces systemic risk more than brown and market ones, respectively. The opposite occurs in the case of an increase in their riskiness in terms of Value at Risk and Expected Shortfall. Banks appear to be systemically more vulnerable to green companies’ riskiness; insurers seem to be more exposed to the riskiness of firms active in the oil & gas industry. The breakdown of the overall ESG scores into E, S and G ones allows to observe that the channels through which sustainability performance of non-financial firms affects banks’ and insurers’ systemic risk are different and that further research is required on this regard. Overall, our findings are important in the perspective of the likely increase in the exposure of financial firms towards more ESG compliant companies, providing useful insights for financial institutions and supervisory agencies in the perspective of the integration of ESG factors in the risk management systems of the former and in the prudential practices of the latter.