How have financial markets reacted to the disclosure of the list of Other Systemically Important Institutions by the European Banking Authority? With an event study of bank stock prices, we document that the immediate reaction of the stock market is negative, suggesting that the included financial institutions are perceived to be less profitable because they are subject to tighter regulation. However, within a few days, investors change their perception in the case of both eurozone and noneuro-zone banks, which can be attributed to their too-big-to-fail status. CDS spreads react similarly, increasing first before decreasing almost immediately thereafter. On the day of the event, abnormal returns are more negative for banks selected using supervisory judgement and for large banks. In the long run, the market reacts more positively in the case of financial institutions selected using discretionary information and those with a lower capitalization.
How do changes in Environmental, Social and Governance (ESG) scores influence banks' systemic risk contribution? Using a dynamic panel model, we document a beneficial impact of the ESG Combined Score and Governance pillar on banks' contribution to system-wide distress analysing a panel of 367 publicly listed banks from 47 countries over the period 2007-2020. Stakeholder theory and theory relating social performance to expected returns in which enhanced investments in corporate social responsibility mitigate bank specific risks explain our findings. However, only better corporate governance represents a tool in reducing bank interconnectedness and maintaining financial stability. The results are robust to alternative measures of systemic risk, both contribution and exposure, as well as when estimating a static model. Our findings stress the importance of integrating banks' ESG disclosure into regulatory authorities' supervisory mechanisms as qualitative information.
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