*Article* **European Financial Services SMEs: Language in Their Sustainability Reporting**

#### **Esther Ortiz-Martínez \* and Salvador Marín-Hernández**

Department of Accounting and Finance, University of Murcia, 3100 Murcia, Spain; salvlau@um.es **\*** Correspondence: esther@um.es; Tel.: +34-868-887-925

Received: 29 August 2020; Accepted: 8 October 2020; Published: 12 October 2020

**Abstract:** In this study we concentrate on the segment of small companies in the financial sector in Europe. Services in this sector are developing rapidly and are not necessarily provided only by traditional banks and financial companies. Many nonfinancial companies provide financial services, and this may open the sector to additional risk. In this context, the aspects of both financial and nonfinancial reporting are important and need to be taken into consideration as a whole to provide a complex picture of a particular institution. The goal of this paper is to analyze sustainability reporting according to the Global Reporting Initiative (GRI) by European financial services small and medium-sized enterprises (SMEs). First, we conducted a descriptive analysis of the features of nonfinancial information and its assurance, studying a sample of all European SMEs reporting according to the GRI from 2016 to 2018. Then, we chose only financial services SMEs to apply lexical analysis to their narrative reporting based on a corpus of 102,056 words. We conclude that nonfinancial information does not have the same importance as traditional financial information, and this sustainability reporting only complies with the minimum requirements. Thus, there is still a long way to go in this field.

**Keywords:** European financial services; SMEs; nonfinancial information; sustainable reporting; disclosure; lexical analysis; nonfinancial reporting

#### **1. Introduction**

Initially, disclosure of nonfinancial information was voluntarily assumed by companies, mainly large global ones. The European Commission decided that the heterogeneity in this field was an inconvenience for transparency and comparability, so it required the compulsory issuance of nonfinancial information by big European groups [1]. Although the transposition of this directive can vary and includes certain flexibility in order to be adopted by each Member State, no state has extended the obligation of issuing this sustainable information to small and medium-sized enterprises (SMEs) [2]. Bearing in mind that most of the companies in Europe are SMEs, it is important to study the nonfinancial information that they provide because disclosure of nonfinancial information is a way to improve companies' transparency and communication of social and ethical practices. The first contribution of this paper is to show which European SMEs are disclosing sustainability reports according to the Global Reporting Initiative (GRI) voluntarily, which will add important knowledge to this field of research traditionally based on large companies.

SMEs are the backbone of the European economy and are traditionally dependent on bank loans for their external financing. The last financial crisis and now the situation generated by COVID-19 have increased both the need for financial resources and the difficulties in accessing it. The European Commission highlights these difficulties and promotes the provision of suitable alternatives to bank loans, so it enacted a specific regulation "to make SMEs more visible to investors and markets more attractive and accessible for SMEs. Regulatory changes will keep the right balance between prudential regulation and financing of SMEs, and between investor protection and tailored measures for SMEs" [3]. This sector is also in the spotlight of transparency after the recent crisis and has an additional obligation with society to try to balance the unequal distribution of information [4]. We focused our study on European financial services SMEs that provide sustainability reports according to GRI standards. The development of this sector is linked to economic growth [5], and the effect of the recent crisis on bank credit has increased the importance of other types of financial resources, such as trade credit [6]. Thus, the recent evolution of the financial sector has turned to SMEs to provide these services because their traditional problems in obtaining financial resources can be more easily solved by other SMEs [7]. Although at first sight the small size can seem to be a limitation to operating in the financial sector, it can be an important advantage because specializing as another SME or in retail services in order to provide a more similar service is seen as a positive way to attract SMEs to this sector [7]. Banks and, by extension, financial services companies are expected to approach climate risks and other risks related to sustainability in the same way that they approach any other financial risks [8].

The development of regulations in Europe to require sustainability reporting by financial services companies and obtain financial resources is under discussion, and recently a roadmap of regulation on taxonomy-related disclosures was launched by undertaking the reporting of nonfinancial information included in the European Commission's Action Plan on financing sustainable growth [9]. European financial sector companies have their own regulatory and supervisory bodies that do not depend on their size in terms of national and international financial compliance, although groups of European listed companies are directly regulated by European Union–International Financial Reporting Standards (EU-IFRS). IFRS also include requirements on disclosure as a response to the need for high-quality standards in order to be endorsed in Europe. In this line, in 2018 the European Securities and Markets Authority (ESMA) expanded its supervisory activities to nonfinancial information on environmental, social, and governance (ESG) matters assessing compliance with IFRS, and in 2019 it continued to focus on this disclosure. When speaking specifically about regulation of nonfinancial disclosure, large financial services companies are mainly considered entities of public interest in each Member State, which means that they are compulsorily required to disclose nonfinancial reporting according to Directive 2014/95/EU, although the specific requirements depend on its transposition by each Member State [1]. Hence, financial services SMEs that publish sustainability information do it voluntarily because they are not within the scope of the directive, and this field is not regulated.

Background information on the field of sustainability reporting of financial services SMEs is scarce and far from sufficient to develop requirements about it now when the European Commission is working on a review of nonfinancial reporting. Studying nonfinancial information is also difficult due to its mainly qualitative and narrative nature, which makes the information heterogeneous. Although most companies are using GRI standards, this does not suppose comparable homogeneous information. Hence, it is necessary to look for another type of methodology, such as lexical analysis, which means studying the words used in the narratives of sustainability reports by European financial sector SMEs, and this is the main objective of this study.

There are three main streams of theoretical framework on which this paper is based. The first refers to disclosure of nonfinancial information and global trends in this subject, such as the general use of GRI standards. Background information about the disclosure of nonfinancial information is mainly based on large companies, which are accustomed to listing because they try to inform their stakeholders and cope with the requirements established by the capital markets [10–12]. All global trends in this field have been adopted by large companies, which are globally shaping the features of disclosure with their voluntary reporting [13]. The generally accepted standards of nonfinancial information are GRI standards because "the GRI guidelines seem to fulfil the need for standards when reporting, identifying and implementing sustainable practices in the companies, since the GRI framework has become, de facto, the standard in sustainability reporting around the world" [14]. Reporting according to GRI standards means there is some kind of homogeneous disclosure as well as use of the GRI database [15–22].

Another important global trend in nonfinancial information is to verify it externally, or to gain assurance, which is linked to disclosure of these issues [23]. All of these practices have been extensively studied at the level of big companies, but background information on SMEs is scarce. Some studies have tried to obtain differences in disclosure between big companies and SMEs [24]. SMEs have fewer resources to report nonfinancial information [10], which does not mean that they do not behave in a sustainable way or do not have a sustainable culture. Studies have also argued that SMEs adopt better corporate social responsibility (CSR) practices, although they do not issue information about it [25]. Until recently, all sustainable reporting was issued voluntarily, but for a few years the European Union has made some kind of nonfinancial information on large companies compulsory [1], and some SMEs issue this information due to the influence of large companies [26] or because they want to gain a competitive advantage [12].

Currently, important work is being done to advise SMEs on how to voluntarily issue nonfinancial information. This is being done by regulators (such as the European Commission), the regulators´ advisors (the European Financial Reporting Advisory Group (EFRAG) advises the European Commission, focusing on disclosure requirements), and professional organizations (the International Federation of Accountants (IFAC) and active organizations representing European SMEs such as the European Federation of Accountants and Auditors for SMEs (EFAA for SMEs) and SMEunited). However, the literature on sustainability reporting by SMEs is scarce and mainly based on a single research method, surveys, which means there is a need for further studies that combine other methods to add additional conclusions about this subject [27]. In this line, we point out the situation of voluntary sustainability reporting according to the GRI by European SMEs, which provides another point of view in a field of research traditionally based on large companies.

Second, there is background information focused on disclosure of financial services companies due to their important role in the economy. This sector has traditionally been a determinant of social issues of companies [28–30] because the information being issued depends on the kind of activity of the firm. Financial services companies are vital agents in the economy, so they are a benchmark for greater transparency [31–33]. They are also under special supervision and regulation in each country, with specific requirements on top of those applied for nonfinancial entities [34], and there can be an effect of the type of market economy on banks´ disclosure (coordinated or liberal market economy) [35]. This vital activity and the effects of the recent crisis have increased research on the relationship between social responsibility and profitability in financial services companies and companies operating in other sectors [36–43]. Nowadays, there is also "ethical banking" in comparison to "conventional banking" because it is supposed to be more responsible and issue more information, both financial and nonfinancial, in response to stakeholders [44,45]. Notwithstanding ethical banking, traditional banking is supposed to take care of different aspects of its social responsibility such as consumer satisfaction [46] and the opinions of providers of financial resources [47]. The European Commission is promoting alternative financial plans for SMEs, trying to make it easier for SMEs to access markets [3], while not forgetting investor protection, which also includes sustainable reporting to respond to the increasing pressure to provide nonfinancial information [48].

The third theoretical framework is related to the methodology that we used in this paper: lexical analysis. The area of study, disclosure of nonfinancial information, is complex because it mainly consists of heterogeneous qualitative and narrative information. It is true that most companies are using GRI standards, but this does not mean there is comparable information, as there are different levels of adherence, and the formats of presenting the information can be quite diverse and flexible. Hence, analyzing disclosure implies many problems, which the majority of studies have tried to solve using content analysis or disclosure indices to measure this information (one recent study using indices is [49]), or to check if there is any relationship between disclosure and other features, although there are proven disadvantages when using this methodology [50]. Lexical analysis has been used in research having to do with semantics and language in a variety of fields, such as in [51,52], which strictly refer to language skills, as well as in analyzing qualitative narrative information in the field of economics,

such as [53], which examined statements by the chairman and CEO in BP plc´s Annual Report 2010 [54], which used lexicometric analysis to study a corpus comprising speeches of European Central Bank presidents; [55], which analyzed the results of open-ended interviews in the field of management; and [56], which used lexical analysis to try to extract the sentiments of a group of people to predict the movement of the stock market. Studies using lexical analysis of nonfinancial reporting are scarce, and none has analyzed disclosure by European financial sector SMEs. Mainly they have focused on big firms, such as [57], which conducted lexical analysis of annual reports of Shell plc.; [58], which reviewed previous research on sustainable banks for three periods depending on the financial crisis and used a descriptive bibliometric analysis and a co-word analysis to study the topics in the literature; [59], which applied lexical analysis to environmental disclosure of listed companies; [60], which asserted that the discourse included in the social reports of BP and IKEA was constructed to present the face that the companies wanted to show; and [61], which created two corpora from seven corporate governance reports of listed companies.

In this paper we use lexical analysis to study disclosure of nonfinancial information because it is mainly narrative, and this is a good way to obtain conclusions from the text provided and the words used to compose the narrative. The analysis is based on reporting by European financial sector SMEs, and the background on this field is scarce. Sustainability reporting in the financial sector is mainly inadequate and focused on financial aspects rather than on material issues, as highlighted by the UN when studying sustainability reporting in the financial sector [62]. Only a few of these initiatives of sustainability reporting provide a picture of all sustainability factors of financial companies [62]. In addition, the overwhelming majority of SMEs perceive sustainability reporting as a burden, and it appears that SMEs either do not have the capacity to comply or are reluctant to invest the necessary resources [63], so taking all this together, we propose the following research questions:

**Research Question 1.** *Are European financial sector SMEs preparing their sustainability reports only in accordance with minimum nonfinancial disclosure requirements?*

**Research Question 2.** *Are European financial sector SMEs still more influenced by financial terms in their nonfinancial reporting?*

The paper is organized as follows: first we describe the methodology, in the next section we discuss the results, and in the final section we wrap up the paper and describe the limitations and future research.

#### **2. Materials and Methods**

As the first goal of this paper is to point out the situation of sustainability reporting according to GRI voluntarily disclosed by European SMEs, we obtained the sample from the GRI database. Bearing in mind that GRI nonfinancial reporting standards are the most widely used all over the world and that SMEs in Europe are not compelled to issue this information, this database is a suitable resource to get these data. The search tool of the GRI database allows searches for nonfinancial reports according to firm size, and specifically reports issued by SMEs. We made our search on 11 November 2019 with the following criteria: firm size—SMEs; region—Europe; report type—GRI-Standards. Although previous versions of the GRI standards are included in the report type, these are the latest ones, published by GRI on 1 July 2018, replacing the GRI 4 version (https://www2.globalreporting.org/ standards/g4/Pages/default.aspx). In total, 116 organizations and 157 reports were found. This means that there are firms (or other types of organizations) that issued more than one report because these standards refer to 2016, 2017, 2018, and even 2019. As shown in Table 1, there are many sectors in which SMEs that issue nonfinancial information operate.


**Table 1.** Nonfinancial information issued by European small and medium-sized enterprises (SMEs) according to Global Reporting Initiative (GRI).

Second, if we focus on the financial services sector, due to the specific features that we highlighted previously, we see that there are only nine reports to analyze. Hence, there are nine sustainability reports by European financial sector SMEs according to GRI, which supposes an important number of reports according to sector based on the breakdown in Table 1, and a percentage of reports (5.7%) important in comparing nearly all sectors, with the exception of real estate, nonprofit services, commercial services, and others. It was necessary to group the sectors in order to get higher percentages of sustainability reports (grouped sector breakdown in Table 1).

Analyzing the language of these reports to see if they can be investigated more deeply, we find (Table 2) that only four out of nine reports are written in English, and the others are in the mother tongue. Although there is no English financial services SME in the sample, the majority of SMEs use English to prepare this information. It does not seem logical to prepare nonfinancial information according to GRI using the mother tongue in response to the market and stakeholders, but we must bear in mind that we focus on SMEs, and their goals in disclosing this information may not be so global.


**Table 2.** Nonfinancial information issued by European financial services SMEs according to GRI.

Hence, only four European financial services SMEs issued nonfinancial information according to GRI standards and, fulfilling the methodological requirements, reported in English. We used all the data obtained from the GRI database during this period, so the sample is the whole population of European financial services SMEs that complied with GRI standards from 2016 to 2018 and wrote their reports in English. From the point of view of the lexical analysis methodology, the studied sample has the appropriate size, measured by the size of the corpus (number of words or tokens) compared to previous valid studies [57,64,65].

We used SPSS to analyze the features of the nonfinancial information and its assurance, showing the frequencies in absolute values and percentages. All features were taken from the GRI database. After describing the features of the nonfinancial information issued by European financial services SMEs in English, we studied the narrative discourse of these reports, as this is the best way to analyze qualitative heterogeneous information. Hence, it was necessary to look for another type of methodology, such as lexical analysis, which involves studying the words used in the narrative. The reports are in PDF format in the GRI database, and to do a lexical analysis it is necessary to convert them into TXT files. We used free PDF-to-text software (https://pdftotext.com/es/) to get four TXT files correspondingly organized according to firm. These files made up the corpus for analyzing nonfinancial disclosure. To analyze the narrative reporting, we used another statistical methodology that allowed us to compare the disclosure to obtain the main characteristics of a corpus and find word patterns. The chosen tool was WordSmith Tools 7 software (version 7, Oxford University Press, Oxford, UK), published by Lexical Analysis Software and Oxford University Press since 1996. We used different utilities that this lexical analysis software offers, which are explained in the Results section.

#### **3. Results**

#### *3.1. Features of Nonfinancial Information and Its Assurance of European Financial Services SMEs*

First, 5.7% of all European SMEs that voluntarily disclosed nonfinancial information according to GRI (9 out of 157) operated in the financial services sector (Table 1). The most important sector in this sample was real estate companies (10.2%; Table 1), and financial services occupies an important position of nonfinancial information according to sector. The nine financial services companies that issued nonfinancial information came from different EU countries (Table 2). There are two effects to bear in mind. First, sometimes SMEs that need credit have to report on some sustainability aspects to align with banks´ sustainability requirements. Second, these SMEs provide financial services, which means they have to report on their own sustainability [63]. As previously pointed out, only four of the nine used the English language to report their nonfinancial information, and five used their mother tongue, although it is supposed that these reports are published for global stakeholders (Table 2).

To get an idea of the importance of this type of SME in Europe, we can highlight that two of the four are asset managers, one in Germany and one in Finland. According to the European Fund and Asset Management Association [65], in 2017 there were 380 asset management companies in Germany (one of the leading European countries with this type of company) and 26 in Finland. Hence, bearing in mind that these numbers are not detailed by company size, we can say that these two SMEs are a good sample to study. The other two European financial services SMEs are a bank in Iceland, a state-owned bank created from an old bank during the last crisis (a national bank, thus its small size), and a provider of financial market infrastructure services in Belgium. The bank's main services are based on consumer, corporate, and private banking; mortgage loans, private equity, wealth management, and credit cards. The German asset manager offers one global investment platform focused on multi-asset alternative credit, real asset debt, and sustainable investments through a digital environment for retail investors. The Belgian provider of financial market infrastructure services acts as an international central securities depository (ICSD) and as the central securities depository (CSD) for some other securities. Retail investors can also have direct accounts in their local CSD. The Finnish asset manager offers asset management solutions and financial advice globally to private investors, institutions, professional athletes, and artists. Finally, the analyzed companies offer a valuable picture of the narrative discourse included in sustainability reports, taking into account particular niches in the financial industry. At the same time, these reports are comparable because all the companies are SMEs operating in the financial services sector, bearing in mind that the sector is one of the most important determinant variables influencing nonfinancial reporting [66–68].

As regards the adherence level, most of the nine European financial services SMEs (80%) adjust their information to the core level of GRI, which is referred to as the "in accordance" core, and prefer not to prepare integrated reports (Table 2). Thus, it seems as if these companies try to issue nonfinancial information following the minimum established standards as highlighted by the UN when it studies sustainability reporting in the financial sector and says that it is not offering information about all sustainability factors of financial companies [69], even more if we are speaking about SMEs.

Bearing in mind the assurance of this information (Table 3), two-thirds of these financial services companies verified the disclosure externally. The predominant level of assurance is limited/moderate, and the assurance scope is a specified section as defined by GRI. The assurance providers in the analyzed reports were mainly accountants (55.5%); one-third of verifications were done by one of the Big Four companies, KPMG (33.3%), and one-third were done following the ISAE 3000 assurance standard. However, the financial services companies did not issue information about this assurance after they verified their nonfinancial information (at least four of them, or 44.4%, did not have this information available; Table 3).


**Table 3.** Features of nonfinancial assurance of European financial services SMEs.

#### *3.2. Lexical Analysis of Sustainability Reporting of European Financial Services SMEs*

First, we used the WordList application to obtain the principal characteristics of the text analyzed. The main features are shown in Table 4. Although the companies are in different countries and the reports are from different years, these data are comparable because all are SMEs and operate in the financial services sector. Finally, we analyzed 102,056 words, which are called tokens, and all together are defined as a corpus. The size of the corpus, and thus of the sample, is appropriate to apply lexical analysis (the number of analyzed words or tokens is always bigger than the corpus analyzed in previous valid studies [57,64,65]).


**Table 4.** Principal characteristics of analyzed sustainability reports.

\* Types: different words that are not repeated in the text. \*\* Standardized TTR: TTR that does not depend on different text lengths.

It can be seen that the four companies are in different European countries. There are no big differences between words in the reports of the last three years, except that in 2016 the reports were much briefer than in the following years. This may be due to the early application of GRI standards or to the fact that companies show greater effort "from year to year in giving more information in order to comply with the transparency principle, or at least to give this appearance" [57]. The same can be checked in the different words used in the reports, which are called "types" in this software, and in the type–token ratio (TTR), calculated as different words over total words, which increases when the number of total words decreases (Table 4). However, when the TTR is calculated without considering the extension of the whole text, standardized TTR, the largest number of different words, without repetition, is found in the latter reports, with the exception of the report of the Icelandic financial services company, which seems to repeat words more frequently although the report is the most extensive (more words and more sentences; Table 4). Perhaps more words are used to say the same thing, and the opposite was the case in the 2016 report; fewer words were used to say the important things, which were not repeated. Although, as mentioned, there is value in a reporting narrative, that does not mean it is an extensive report because a sustainability report is not for

storytelling [70]. Previous studies on the relationship between disclosure length and greater readability, transparency, or complexity were inconclusive [71] and were not focused on financial services SMEs.

The next tool used in the lexical analysis was the word list (results are shown in Table 5). This counts the frequency of words used in the corpus, i.e., how often each word appears in the whole text, and their percentage of use in the text. The position is the ranking of the most frequently used words. We included in Table 5 the most significant frequent words for this analysis (the first position is included as an example). Only the word "risk" appeared in more than 1% of the cases in the corpus (1.04%), in position 8, followed by "bank" in position 12 and "management" in position 20. To classify these most frequent words, we created three groups: words that are basically related to financial meaning such as "risk", "bank", "management", "financial", "capital", "investment", "business", and "funds"; other words that have to do with the core sense of nonfinancial information, such as "employees", "sustainability", "board", "environmental", "committee", "governance", "pillar", and "GRI"; a group with words related to information and requirements, such as "information", "compliance", "reporting", "disclosures", and "requirement". This classification was based on the assignment of a certain term to a concept, which can be done in specialized languages, as in this case, when analyzing sustainability reporting; for example, the word "meager" is identified as a specialized term in the realm of finance, since it is very commonly used in expressions such as "meager economic recovery" and "meager 10%" [71]. Although the word "pillar" is included in the financial group, it could also be included in the second group related to nonfinancial aspects, which we called sustainable most frequent words. This is due to the Basel II and III requirements, which ask for reporting on financial and nonfinancial items of these kinds of companies, so it contains both dimensions of the concept, financial and nonfinancial. Although these three groups of most frequent words were made following the assignment of terms to concepts in specialized languages [72], sometimes some words refer to more concepts and the assignment is not so simple.

The following results were obtained from the analysis of the most frequent words, shown in Tables 6–8. The number of occurrences of the search word (hits), occurrences of each word per 1000 words, and their dispersion are calculated. To establish comparisons, it is better to use hits per 1000 words as a homogeneous measurement. As can be seen, "financial" words are used the most: the occurrences per 1000 words were clearly the highest for these kinds of words. The most used was "risk" (10.16 times per 1000 words), followed by "bank", "management", and then a sustainable word, "sustainability" (3.75 times per 1000 words; Table 7) followed by other financial words: "financial", "capital", "investment", "business" (2.40 times per 1000 words), and then "employees", previously included in the group of sustainable words (2.29 times per 1000 words) and "GRI" (2.13 times per 1000 words). This means that what counts the most in sustainable reports is the financial information over the nonfinancial information, or at least the typical financial aspects of the business are highlighted more with the use of the language. These companies do not seem to include sustainable words in their vocabulary and, hence, in their culture. Although the four companies are in different countries and operate in different niches of financial services, the results are similar when classifying the most used words.

Analyzing the information on the use of these frequent words considering the four reports separately, we can see that some of the words appear to be used more because they are used very often in some reports, which increases the global frequency in the corpus. This is the case of the words "risk", "bank", and "capital" (20.15, 18.23, 6.80 per 1000 words; Table 6), which occur frequently in the report of the financial services company in Iceland. The word "sustainability" appears as the second most frequent in this group due to its use in the Finnish company's 2016 report, although it is only used in three of the four reports (8.10 per 1000 words; Table 7). Something similar happens with the word "employees", whose use increases due to the Finnish company's report (5.36 per 1000 words, Table 7). The case of the word "pillar" deserves some reflection because, although it is a frequent word in the corpus, the detailed analysis of the reports showed that it was only used in two, and essentially only in one because the frequency of use in the other was very low. Thus, "pillar" was exclusively used

by the financial services company in Iceland in its 2018 report (Table 7). Another example is the term "GRI", which would be expected to appear in all of the reports, given that all are prepared according to GRI standards, yet it did not appear in one report, which is one of the most recent ones (Table 7).


**Table 5.** Word analysis of sustainability reports.







Hits: number of occurrences of the search word. \*\* Per 1000 words: number of occurrences per 1000 words. Dis., dispersion.

SME1

SME2

SME3

SME4

 4 \*

 0.42

 0.465

 6

 0.25

 0.582

 34

 1.16

 0.730

 101

 2.19

 0.815

Analyzing Table 8, with the statistics of the most important frequent words related to information and compliance in the sustainability reports, there was one report in which they had less importance, as was previously obtained, that of the Belgian company from 2017. The most used words in the other three reports were those generally obtained as the most frequent words; hence, they follow the general pattern. For example, "information" showed higher frequency per 1000 words in the German and Finnish reports (SME2 and SME4: 2.91 and 2.84, respectively; Table 8) and so on with the other words.

The last three tables of this analysis (Tables 9–11) include the results obtained from the concordance tool of the lexical analysis. The last step is to analyze the most frequent words in their context. This means counting the number of times one word is found in the neighborhood of the chosen word. This tool allows us to discover whether or not the most frequent words are related to the disclosure they supposedly refer to. The method of considering the relationships between certain words and the other words that appear a sentence was used in previous studies, such as [73]. All the tables of concordance include the first eight words with the most important relationships (in the tables, they are in positions from 1 to 8, and position 1 is always the most frequent word analyzed). In the case of the word "requirements", its position 8 showed very low frequency, and it was not included in Table 11.


**Table 9.** Concordance of most important financial frequent words in sustainability reports.

\* Total: number of times the word was found in the neighborhood of the search word.


**Table 10.** Concordance of most important sustainable frequent words in sustainability reports.

\* Total: number of times the word was found in the neighborhood of the search word.

**Table 11.** Concordance of most important frequent words related to information and compliance in sustainability reports.


\* Total: number of times the word was found in the neighborhood of the search word.

The words that were previously grouped as financial terms in the analysis of the most frequent words are related to the same type of financial words: bank–risk, management–risk, financial–services, capital–bank–risk, business and risk, and funds–investment–bank (all are in position 1, 2, or 3 in Table 9, which means they appear next to each other). The only most frequent financial word included previously that was more frequently related to other sustainable terms was "investment", appearing in the reports with "responsible" and "sustainable" (Table 9).

The most frequent words about sustainable aspects appeared fewer times that the financial ones (Table 10), and the concordance shows the following:


The majority of results included in Table 11 go further in the importance of the words "compliance", "requirements", "disclosures", and "risk". According to GRI good practices for SMEs, sustainability reporting has to comply with the following checklist: it describes the sustainable development and draws objective and available information and measures of sustainable development, presents the performance of sustainable conditions and goals and the magnitude of the contribution to (un)sustainability, and describes the relationship between sustainability and long-term organizational strategy, risks, and opportunities [74]. Thus, if we use this lexical analysis to understand whether these financial services SMEs properly developed their sustainability reporting, the obtained results show that although they used some specific words to meet the minimum requirements, the financial dimension of reporting continues to be more important, and the other information is used to increase the length of the report but still does not reflect significant environmental and social impacts. According to previous studies [75], sustainability reporting in financial companies has as the highest priorities those directly related to their business operations.

#### **4. Discussion**

Our analysis is based on European SMEs included in the GRI database, hence the population of SMEs that voluntarily use GRI standards, although only between 10 and 15% of sustainability reports in the database from 2017 to 2018 came from SMEs [76]. Then, we focused on European SMEs operating in the financial services sector. Bearing in mind their specific activity, sustainability reports by European financial sector SMEs represent an important percentage of reports in comparison with nearly all other sectors (5.7%).

The results obtained from the lexical analysis lead us to think that the answer to our first research question is yes because there is no significant use of symbolic concepts in the narrative discourse in the reports analyzed; hence, there is minimum compliance with nonfinancial requirements. Opposite results were obtained by the authors of [53] after applying a lexicometric analysis to speeches delivered by European Central Bank presidents, although in this case we analyzed sustainability reporting.

Although initially it may be thought that sustainability reports are specific for each company, the broader corpus analysis suggests they were prepared similarly and used the same template [52], even more if it is pointed out that the four companies are in different countries and, although operating in financial services, are focused on different niches. As the sector is a strongly determinant variable of nonfinancial reporting [66–68], the analyzed reports follow the same pattern. Financial services

companies not only operate in the same sector, but they also have their own regulatory and supervisory bodies. In this case the sector is decisive in following the same financial trend in sustainability information, and as found in KPMG´s 2017 survey, financial services companies are in last place in corporate responsibility reporting [77].

These financial services companies are still imbued with traditional financial objectives and information. This means that what counts most in sustainable reports is financial information over nonfinancial, or at least the typical financial aspects of the business in this important sector are highlighted more through the language used. The analysis of the most frequent words in context shows that all financial terms are related to other financial terms. Hence, our second research question is supported. These results are the same as those obtained in previous studies, although in developing countries, based on financial services companies, because it is argued that the most important priorities of these enterprises are those directly related to their business operations [75].

Although a first view of sustainable reporting may show that companies try to exert more effort to increase the extent of their disclosure, the deep lexical analysis of these reports shows that the language used is not so extensive or rich, as some words are repeated many times, which highlights the problem of the lack of content in sustainability information. This shows evidence of the gap that still exists between financial and nonfinancial information and takes us to the same question posed by other researchers: "If it is like this for disclosing firms, what is happening in the case of nondisclosing firms?" [55].

Future research directions depend on an increase in nonfinancial reports, which will make it possible to get a bigger sample, more companies, and a longer period. Currently, the most important limitation is the number of sustainability reports published according to GRI by European financial services SMEs. Another future research project involves using a proper sample of nonfinancial reports to describe and compare financial sector vs. nonfinancial sector SMEs and financial sector SMEs vs. large financial sector companies.

#### **5. Conclusions**

These financial services SMEs should particularly focus on the proper elaboration and publication of sustainability reporting. There are many initiatives to increase the importance of this type of company in Europe and to move toward more sustainable finance. There is a challenge for these companies, taking into account all of their stakeholders, to give the proper role to nonfinancial information. It is desirable that SMEs, as well as those that operate in the financial services sector due to their essential role in the economy, start issuing nonfinancial information, especially now, when alternatives to traditional bank financing are being promoted for financing SMEs. These results and conclusions have theoretical and practical implications for the importance of sustainability reporting. It may be a burden, but it can also have multiple advantages, such as being an opportunity to create value in the company, differentiate from other companies, improve operational performance, or enhance market reputation, among others. Our contribution with this work is to point out that these financial services SMEs play an important role, and sustainability reporting has to mean there is another way to do business [78]. This study provides an opportunity to improve sustainability disclosure and standards considering the specific features of financial services SMEs. Regulators must take into account the specific features of this type of company in order to adapt the standards and requirements. Sustainability reports must include all relevant topics that reflect the organization´s economic, environmental, and social impacts or influence the decisions of stakeholders [74]. The main reasons argued for not having proper sustainability reporting by SMEs are the lack of resources, awareness of sustainability´s importance and potential impacts, access to financing, information and skills to elaborate this information, and regulatory requirements [76]. Thus, this is an opportunity for practitioners, academics, and regulators to try to solve these problems from all points of view, theoretical and practical, to make up for this lack of resources according to their different tasks. Now, when the European Commission is working on amending the nonfinancial reporting directive

through the mission of the European Financial Reporting Advisory Group (EFRAG) and its Project Task Force on nonfinancial reporting standards, it is time to think about these specific features of SMEs and financial services companies to make the process of sustainability reporting easier.

**Author Contributions:** Conceptualization, E.O.-M. and S.M.-H.; methodology, E.O.-M. and S.M.-H.; software, E.O.-M.; validation, S.M.; formal analysis, E.O.-M. and S.M.-H.; investigation, E.O.-M. and S.M.-H.; resources, E.O.-M. and S.M.-H.; data curation, E.O.-M. and S.M.-H.; writing—original draft preparation, E.O.-M. and S.M.-H.; writing—review and editing, E.O.; visualization, S.M.-H.; supervision, E.O.-M. and S.M.-H. All authors have read and agreed to the published version of the manuscript.

**Funding:** This research received no external funding.

**Conflicts of Interest:** The authors declare no conflict of interest.

#### **References**


© 2020 by the authors. Licensee MDPI, Basel, Switzerland. This article is an open access article distributed under the terms and conditions of the Creative Commons Attribution (CC BY) license (http://creativecommons.org/licenses/by/4.0/).

**Begoña Torre Olmo, María Cantero Saiz \* and Sergio Sanfilippo Azofra**

Business Administration Department, Faculty of Economics and Business, University of Cantabria, Avd. Los Castros S/N, 39005 Santander, Cantabria, Spain; torreb@unican.es (B.T.O.); sanfilis@unican.es (S.S.A.) **\*** Correspondence: canterom@unican.es

**Abstract:** The financial crisis seriously damaged the reputation of the banking sector, as well as its profitability and risk of insolvency, which led many banks to adopt a sustainable approach aimed at balancing long-term goals with short-term performance pressures. This article analyses how sustainable banking practices affect the profitability and the insolvency risk of banks. Moreover, we examine how sustainable strategies determine the effects of market power and efficiency on bank profitability. We used a two-step System-GMM to analyze an unbalanced panel of 1236 banks from 48 countries over the period 2015–2019. We found that sustainable banking practices increased profitability, and market power was an important determinant of profitability among conventional banks, but not among sustainable banks. Higher levels of cost scale efficiency led to greater profitability for both sustainable and conventional banks. However, there was no significant relationship between sustainable banking and insolvency risk. These results indicate that the traditional determinants of bank profitability are not relevant in explaining the superior profits of sustainable banks, which suggests the emergence of a new paradigm related to sustainability among the drivers of bank profitability.

**Keywords:** sustainable banking; market power; efficiency; profitability; risk

#### **1. Introduction**

During the global financial crisis of 2008, the banking sector focused too much on financial results while disregarding other aspects of business, which led to the banks' failure and seriously damaged their reputation. Banks have attempted to recoup this damaged reputation and restore trust by implementing sustainable business strategies [1,2]. Sustainable practices are aimed at supporting the environment, society, and the economic benefit of the business simultaneously, which can have important effects on bank profitability [3]. Traditionally, the profitability of the banking sector has been explained mainly by two hypotheses [4]. The market power hypothesis considers that greater market concentration, or market power, facilitates the setting of higher profits for customers, which increases windfall profits for banks, while the efficiency hypothesis assumes a positive relationship between efficiency and bank profits.

Some articles have analyzed the profitability of sustainable banks [1,5,6], but none has considered how sustainable banking affects the traditional hypotheses of market power and efficiency. The first contribution of the article is thus to analyze how sustainable practices determine the effects of market power and efficiency on bank profitability. The analysis of these aspects is very important because the financial crisis not only led banks to adopt sustainable activities; it also reduced the profitability of banks, increased the concentration of the banking industry due to mergers and acquisitions, and strengthened the differences between more and less efficient banks because the former could reduce costs, avoid excessive delinquency, and get better financing conditions [7].

Sustainable business models offer competitive advantages for banks, such as better reputation and brand differentiation, which attracts more loyal customers and increases

**Citation:** Torre Olmo, B.; Cantero Saiz, M.; Sanfilippo Azofra, S. Sustainable Banking, Market Power, and Efficiency: Effects on Banks' Profitability and Risk. *Sustainability* **2021**, *13*, 1298. https://doi.org/ 10.3390/su13031298

Academic Editor: Stefan Cristian Gherghina ¸ Received: 22 December 2020 Accepted: 22 January 2021 Published: 26 January 2021

**Publisher's Note:** MDPI stays neutral with regard to jurisdictional claims in published maps and institutional affiliations.

**Copyright:** © 2021 by the authors. Licensee MDPI, Basel, Switzerland. This article is an open access article distributed under the terms and conditions of the Creative Commons Attribution (CC BY) license (https:// creativecommons.org/licenses/by/ 4.0/).

market share. However, it is likely that sustainable banks will not exploit their greater market power to impose higher prices on customers, as proposed by the market power hypothesis. Instead, these banks would use other competitive advantages, such as emotional factors or differentiated business cultures and values to capture customers' loyalty and boost profits [8]. We thus propose the following hypothesis:

**Hypothesis 1 (H1).** *The market power hypothesis is less relevant in explaining bank profitability for sustainable banks than for conventional banks*.

Conversely, sustainable practices are costly, which can have adverse effects on bank efficiency [9]. Nevertheless, sustainable actions also improve banks' reputation, which lowers their funding costs and gives them access to more investments [10,11]. Moreover, these actions also strengthen the sustainability standards of the banking industry, which raises competitors' costs [12]. Therefore, it is likely that the positive effects of sustainable strategies on bank efficiency compensate for the negative ones and, thus, sustainable banks tend to be as efficient as conventional banks. Consequently, we propose the following hypothesis:

#### **Hypothesis 2 (H2).** *The relevance of the efficiency hypothesis in explaining bank profitability is similar for both sustainable and conventional banks*.

Not only can sustainable practices determine the relationship between profitability, efficiency, and market power, but they can also affect banks' insolvency risk: the risk of a bank being unable to fulfil its obligations of repaying its debt. Although studies on the relationship between sustainability and financial performance are relatively numerous, the relationship between sustainability and bank stability has not received enough attention from researchers and remains open to debate even today [13]. The second contribution of this article is thus to analyze how sustainable banking strategies affect insolvency risk. The study of ways to reduce insolvency risk deserves special attention because during the crisis, financial institutions faced huge losses from credit defaults, high levels of uncertainty, and strong funding restrictions [14,15]. This is important as insolvency risk not only affects the bank itself, but also may influence the entire financial system [16].

Sustainable strategies can reduce insolvency risk because they improve brand image and attract customers, which lowers reputational risk [11,17]. Sustainable banks also tend to have a greater degree of transparency and higher moral standards, which mitigates adverse selection and moral hazard problems [18]. Moreover, banks with higher funding stability are more prone to invest in sustainable activities [19,20]. So, we propose the following hypothesis:

#### **Hypothesis 3 (H3).** *Sustainable banking practices lead to a reduction in bank risk*.

To test Hypotheses 1–3, we performed empirical analysis of a sample of 1236 banks from 48 countries over the period 2015–2019. We defined sustainable banks as those that voluntarily joined the United Nations Principles for Responsible Banking (UNEP Finance Initiative). The analysis was performed using the System-GMM (generalized method of moments) methodology for panel data, which makes it possible to control both unobservable heterogeneity and the problems of endogeneity through the use of instruments [21].

Our results show that sustainable initiatives lead to higher profits. Moreover, conventional banks that operate in more concentrated markets obtain superior profits, whereas this effect is not observed among sustainable banks, and a larger banking concentration does not affect their profitability significantly. On the other hand, higher levels of cost scale efficiency lead to higher profitability for both conventional and sustainable banks. Finally, sustainable strategies do not have a significant impact on insolvency risk. These results show that the traditional determinants of bank profitability are not relevant in explaining

the superior profits of sustainable banks, which suggests the emergence of a new paradigm related to sustainability among the drivers of bank profitability.

The remainder of the article is structured as follows: Section 2 reviews the previous literature, Section 3 focuses on the empirical analysis and the discussion of the results and Section 4 presents the conclusions, followed by the bibliography and appendices on the procedures followed in calculating the efficiency and scale economies.

#### **2. Literature Review**

#### *2.1. Sustainable Banking and the United Nations Principles for Responsible Banking*

Reputation has been always important in banking due to asymmetric information, the qualitative-asset-transformation made by banks and the systemic risk created by the supply of payment and risk management services [22,23]. Since the global crisis of 2008, the banking sector has been especially affected by reputational risk. Several frauds, software failures, and the financial risks of the crisis of 2008 have not helped to improve the negative perceptions among customers and other stakeholders, and have increased skepticism of commercial banks' motives and actions [1,24].

A possible way to improve banks' reputation and restore credibility would be to promote banks' engagement in sustainable activities, which implies integrating environmental protection, social responsibility and financial benefit into management and business operations [25]. Sustainable development has been the priority of many international organizations, but probably one of the most important steps was made in 2015 by the United Nations (UN) with the adoption of Sustainable Development Goals (SDGs) to address several global challenges by the target date of 2030, including the reduction of poverty, inequality, illiteracy, climate change, and environmental degradation, as well as the defending of human rights and dignity.

The banking sector can play a crucial role in achieving these goals because its involvement in sustainable activities has a potential impact on the sustainability of other industries through the lending channel [26,27]. For instance, banks can be directly involved in projects that protect the environment (green finance), orient funds according to the environmental risk of the target companies or promote socially responsible products [28]. Banks can also offer micro-loans and mobile banking to promote financial inclusion and alleviate poverty, or they can provide women's microcredit to contribute to gender equality [3].

Conscious of these aspects, the UN launched the Principles for Responsible Banking (UNEP Finance Initiative), which banks can voluntarily sign, in September 2019. The purpose of this initiative is to increase lending that supports socially and environmentally sustainable economic activities through six principles that signatory banks must implement within four years [29]. The six principles are, first, alignment: banks must align their business strategy to SDGs, the Paris Climate Agreement and relevant national and regional frameworks. Second, impact and target setting: banks must continuously assess the impact of their activity on people and the environment; moreover, banks have to set and publish targets where they have the most significant impacts. Third, clients and customers: banks must develop sustainable practices with clients and customers and enable economic activities that create prosperity for current and future generations. Fourth, stakeholders: to achieve society's goals, banks must responsibly consult, engage, and partner with relevant stakeholders. Fifth, governance and culture: banks must implement effective governance and a culture of responsible banking. Finally, transparency and accountability: banks must periodically review the six principles and be transparent about and accountable for their impacts and contributions to society's goals. The signatories´ progress on these principles is reviewed every year and banks that cannot evidence the necessary changes will lose their status as a signatory.

Apart from the previous obligations, the UNEP Finance Initiative also provides several benefits to its signatories [29]. First, the six principles offer unparalleled opportunities for collaboration within the banking sector. Signatories to the Principles for Responsible Banking benefit from the collective expertise of the largest community of sustainable

bankers globally. By working collaboratively under the auspices of the UN, signatory banks jointly deliver tools, methodology and practical guidance far beyond what any conventional bank could achieve on its own. This collaboration is based on 11 Working Groups composed of representatives from across the signatory banks. Each focuses on a different aspect of implementation, including: impact analysis, knowledge sharing, target setting and progress evaluation. These outputs are uniquely positioned to shape global best practice and influence emerging regional regulation. Moreover, collective initiatives create the space for banks to jointly push beyond current practice and define new standards for sustainability leadership. Second, unlike conventional banks, all signatory banks have access to an individual feedback and support provided by the UNEP Finance Initiative. This takes a look across their business and makes recommendations on steps the banks can take to further progress their implementation of the principles. Third, signatory banks are able to access additional tools and resources for implementation that are not available for conventional banks. For instance, the Communications Toolkit is designed to assist signatories with communicating and promoting the Principles for Responsible Banking, and includes infographics, social media cards, graphics and other materials. On the other hand, the Peer Learning Repository allows peers sharing their approaches to implementing the Principles for Responsible Banking.

In short, banks have opted to become signatories because they recognize that the needs and demands of their clients and stakeholders are shifting. By implementing the Principles for Responsible Banking, banks can create sustainability value for society, as well as serve their business interests. Starting with only 30 founding signatory banks, the UNEP Finance Initiative included 193 banks from 56 countries by October 2020, including top international banks, regional leaders, development banks, and specialized environmental banks. Figure 1a represents the geographical distribution of these banks. More than 50% of the signatory banks come from Europe, followed by Asia, but with a much lower representation (14%). The remaining world regions account for about the 30% of the signatory banks. Africa and South America represent 8% each; North America and Central America and the Caribbean account for 6% each; and Oceania contains 3% of the signatory banks. In terms of the year of joining the initiative, 157 banks representing more than 80% of the signatories joined the initiative in 2019. During 2020, only 36 banks were added, mainly from Asia and Europe (see Figure 1b).

**Figure 1.** (**a**) Geographical distribution of signatory banks of the United Nations (UN) Principles for Responsible Banking; (**b**) Number of banks by year of signature of the UN Principles for Responsible Banking.

Table 1 shows that more than half of the European signatories come from Norway, Spain, the United Kingdom, France, and Germany; in Asia, more than half of the member banks are headquartered in Japan, South Korea, and China. Most of the African banks

operate in Nigeria, Egypt, and South Africa; and in South America, signatory banks are concentrated in Ecuador and Brazil. More than 70% of member banks in North America come from Canada and Mexico, whereas in Central America and the Caribbean, this percentage is represented by Panama, El Salvador, and Costa Rica. In Oceania, only Australian banks have joined the UN initiative.


**Table 1.** Countries that have joined the UN Principles for Responsible Banking.

#### *2.2. Sustainable Banking, Market Power, Efficiency, and Profitability*

Joining sustainable initiatives, such as the UNEP Finance Initiative, implies integrating social, environmental, and economic aspects, which can have important effects on banks' profitability. Indeed, many articles have shown that the involvement in sustainable activities improves bank profitability [1,5,6,30]. Traditionally, the profitability of the banking sector has been explained through two main theories: the market power hypothesis and the efficiency hypothesis.

The market power hypothesis considers that greater market concentration or market share facilitates setting higher prices to customers, thereby increasing extraordinary profits [4]. This hypothesis has two versions: the structure-conduct-performance (SCP) hypothesis and the relative market power (RMP) hypothesis. The SCP considers that the greatest profits come from highly concentrated markets due to competition concerns and the existence of entrance barriers [31]. The RMP proposes that only banks with significant market share and differentiated products can exercise effective market power [32].

The efficiency hypothesis suggests that more efficient banks have lower unit costs, so they can attract more customers, because lower unit costs would make it possible to set lower interest rates for loans and higher interest rates for deposits [4,33]. The origin of this greater efficiency could come from superior management skills and production technology (X-efficiency hypothesis) or scale economies (scale-efficiency hypothesis). Both the market power and efficiency hypotheses have found wide empirical support [7,34–38].

Sustainable business models can boost market share because socially and environmentally responsible actions improve reputation, confidence, and customer loyalty [39,40]. Consumers of sustainable products and services are more loyal because they not only care about the consumption experience, but also want to form part of a community or wish to belong to a social group when purchasing goods [41]. This loyalty is especially relevant in the financial sector, because competition is normally very intense, and customers have close business relationships with their banks [42].

Bussoli et al. [43] have shown that social initiatives by European financial institutions capture the trust and the loyalty of customers, while Yip and Bocken [44] and Agirre-Aramburu and Gómez-Pescador [2] have reported the same evidence for the banking industry in Hong Kong and Spain, respectively. Apart from social initiatives, environmental initiatives are also very welcome among customers, and many banks now provide green financial products. Fay [45] has shown that green customers buy more products and spend more when doing so. Mason [46] has argued that green customers are willing to pay a premium price for environmentally friendly products, so banks that finance firms that make such products may indirectly benefit from this green premium. Furthermore, Sun et al. [47] have reported that green banking initiatives strengthen the relationship between corporate social responsibility and consumer loyalty.

According to the market power hypothesis, a larger market share facilitates the setting of higher prices to customers, which increases windfall profits for banks. However, sustainable banks tend not to take direct advantage of their greater market share to impose higher prices for customers. Instead, their competitive advantage is based on emotional factors, such as an appreciated difference in business principles and culture or better scores in non-financial performance indicators than conventional banks [2]. This is because sustainable banks are less concerned with short-term profit-maximization and are rather oriented towards maximizing stakeholder value and client satisfaction by decreasing the harmful effects of economic activities on the environment and society [48].

Matute-Vallejo et al. [8] have found that customers in the banking industry do not perceive a bank's sustainable engagement as an attempt to instrumentalize social issues in a manner ultimately intended to increase prices. The Global Alliance for Banking on Values (GABV) [49,50] has also found evidence that sustainable banks are more profitable because they attract more deposits and provide more loans than conventional banks. However, their returns are more stable, which reinforces their focus on long-term profitability instead of obtaining immediate rents through higher prices. In this regard, as we proposed in our Hypothesis 1 (H1) in the Introduction section of the article, we expect that sustainable banking practices will weaken the market power hypothesis.

Although the relevance of the market power hypothesis may vary across sustainable and conventional banks, in terms of the efficiency hypothesis, however, the differences between both types of banks would be less pronounced. Sustainable strategies still raise concern among bank managers because the fulfilment of sustainable responsibilities could be at the expense of increased costs and reduced efficiency [25]. Sustainable banks can risk losing efficiency if they put too much emphasis on social and environmental investments [9]. Furthermore, trying to satisfy all stakeholders could adversely affect profitability due to inefficient use of resources [51,52].

Conversely, sustainable practices can also be valuable assets that contribute directly to the recovery of bank efficiency. First, a good, strong relationship with all stakeholders can help sustainable banks find more investments and help them access and use resources more efficiently [10,53]. Second, sustainability may boost banks' reputation and customer

loyalty, which in turn would translate into lower funding costs [11,54]. For instance, green bonds have lower yields and superior ratings than conventional bonds because investors reward environmentally responsible actions [55]. Third, sustainable activities can also help banks to improve efficiency in relation to their competitors. If a bank implements these activities, future industry sustainable standards are strengthened, which raises competitors' costs [12,56]. Moreover, banks pursuing a proactive sustainable strategy are most likely the ones with greater financial resources and superior management capabilities [57,58]. In this regard, sustainable banks can increase motivation and retention, as employees react positively to the opportunity to weave environmental and social dimension into their work [59]. Therefore, it is likely that these positive effects of sustainable activities on bank efficiency offset the negative ones and, thus, sustainable banks would tend to be as efficient as conventional banks. We therefore propose that the efficiency hypothesis is similar across conventional and sustainable banks, as we suggested in our Hypothesis 2 (H2).

#### *2.3. Sustainable Banking and Risk*

Apart from affecting bank profitability, market share, and efficiency, sustainable activities can also have effects on bank risk. These effects are very important because a healthy banking system is the key to sustainable prosperity, and the security and the soundness of banks can create different external benefits for society [60]. Sustainable strategies can thus lead to a reduction in bank risk, as we proposed in our Hypothesis 3 (H3), for several reasons.

First, by becoming sustainable, banks state that their goal is to link decisively the fulfilment of local community needs with environment protection and sound economic prospects [48]. In achieving this goal, they try to avoid excessive risk taking and better manage risks [61,62]. Rajput and Oberoi [63] have shown that establishing good relationships with the community increases local support and attracts customers, thereby reducing bank risk. Other authors revealed that, by implementing environmentally friendly actions, banks reduce their reputational risk and increase customer loyalty, which leads to higher funding stability [11,17].

Second, a higher level of sustainable activism is associated with higher quality of earnings, a greater degree of transparency and higher moral standards. These factors help banks to mitigate adverse selection and moral hazard problems, which are among the main causes of non-performing loans [18,64]. Saïdane and Abdallah [13] have shown that sustainable banks in Europe are better able to absorb shocks and reduce the risk of insolvency. Moreover, Scholtens and van't Kloose [16] have found that banks with high sustainability scores, especially the social dimension, have lower default risk, as well as lower contribution to financial system risk. Cui et al. [65] have revealed that allocating more green loans to the total loan portfolio reduces the non-performing loan ratio of Chinese banks. Gangi et al. [28], for a sample of 35 countries between 2011 and 2015, have found that banks that are more sensitive to environmental issues also exhibit less risk. The measurement and impact of environmental issues on banking risk has received special attention because crises will increasingly arise from the sheer scale of systemic environmental risks with global effects [66]. Climate-related risks have been identified by the European Central Bank (ECB) as a key risk driver on the Single Supervision Mechanism (SSM) Risk Map for the euro area banking system, and the European Banking Authority (EBA) has been given several mandates to assess how environmental, social, and governance (ESG) risks can be incorporated into the three pillars of prudential supervision [67].

Third, sustainability initiatives normally come from less risky banks. The availability of financial resources incites banks to invest in environmental or social projects, so financial stability is an important condition for investing in responsible activities [19,20]. The GABV [49,50] has found that sustainable banks have stronger capital positions and lower levels of return volatility. Furthermore, Chollet and Sandwidi [68] have reported a virtuous circle between sustainability and risk. In this regard, good social and governance

performance reduces financial risk and thereby reinforces commitment to good governance and environmental practices.

#### **3. Empirical Analysis**

#### *3.1. Selection of the Sample*

To test the Hypotheses 1–3 proposed previously, we conducted an empirical analysis, which is reported in this section. To select the sample for the analysis, we started with all of the banks in the S&P Capital IQ database (S&P Global Market Intelligence). First, we eliminated banks with no available data. Then, we removed banks with errors in their financial statements or when their values were unreasonable, such as those with negative values for total assets, total liabilities, equity, loans, deposits, interest, and noninterest, as well as operating expenses, investment securities, fixed assets, total employees, and efficiency.

We also excluded banks with data available for less than four consecutive years between 2015 and 2019, and countries without the necessary macroeconomic data. The former condition is essential to test for second-order serial correlation, which is performed to ensure the robustness of the estimates made by System-GMM [21]. Moreover, this sample period covers all of the years since the UN's adoption of SDGs. Finally, to avoid bias and spurious correlations between macroeconomic variables and bank level variables, we removed the countries with fewer than five banks in the sample [69].

The final sample consisted of an unbalanced panel of 1236 banks from 48 countries (Austria, Bangladesh, Belgium, Bolivia, Brazil, Bulgaria, Canada, China, Colombia, Costa Rica, Croatia, the Czech Republic, Denmark, Egypt, France, Germany, Greece, Hong Kong, Hungary, Indonesia, Ireland, Israel, Italy, Latvia, Luxembourg, Malaysia, the Netherlands, Nigeria, Norway, Oman, Pakistan, Peru, the Philippines, Poland, Portugal, Romania, Russia, Saudi Arabia, Serbia, Slovenia, South Africa, Spain, Sweden, Switzerland, Turkey, the United Kingdom, the United States, and Vietnam) between 2015 and 2019 (5915 observations). Table 2 shows the number of banks and observations for each country and the temporary distribution of the sample. The financial information on each bank comes from the S&P Capital IQ database (Global Market Intelligence). The macroeconomic information comes from the International Monetary Fund database and the World Bank's World Development Indicators.


**Table 2.** Sample description.


#### **Table 2.** *Cont.*

Obs.: Observations.

#### *3.2. Profitability Analysis*

#### 3.2.1. Econometric Model of the Profitability Analysis

To perform the profitability analysis, we followed Berger [4], who proposed the estimation of the market power and efficiency hypothesis through a single equation. To evaluate these hypotheses for sustainable and conventional banks and to test the differences between both types of banks we proposed the following model:

$$\begin{aligned} \mathbf{R\_{i,t}} &= \boldsymbol{\beta\_0} + \boldsymbol{\beta\_1} \mathbf{S\_i} + (\boldsymbol{\beta\_2} + \boldsymbol{\beta\_3} \mathbf{S\_i}) \times \text{CONC}\_{\mathbf{m,t}} + (\boldsymbol{\beta\_4} + \boldsymbol{\beta\_5} \mathbf{S\_i}) \times \text{MS}\_{\mathbf{i,t}} + (\boldsymbol{\beta\_6} + \boldsymbol{\beta\_7} \mathbf{S\_i}) \times \text{XEF}\_{\mathbf{i,t}} + \boldsymbol{\beta\_6} \mathbf{S\_i} \\ & (\boldsymbol{\beta\_8} + \boldsymbol{\beta\_9} \mathbf{S\_i}) \times \text{SEF}\_{\mathbf{i,t}} + \boldsymbol{\beta\_{10}} \mathbf{EQUITY\_{i,t}} + \boldsymbol{\beta\_{11}} \mathbf{LOADS\_{i,t}} + \boldsymbol{\beta\_{12}} \mathbf{SIDE}\_{\mathbf{i,t}} + \boldsymbol{\beta\_{13}} \mathbf{AGDP}\_{\mathbf{m,t}} \\ & + \boldsymbol{\sum}\_{t=1}^{\mathbf{T}} \text{YEA} \mathbf{R}\_t + \sum\_{m=1}^{M} \text{COUNTRY}\_m + \boldsymbol{\varepsilon\_{i,t}} \end{aligned} \tag{1}$$

The dependent variable (Ri,t) is a measure of the profitability of banks: ROA (return on assets) and ROE (return on equity). ROA is the ratio of net income over total assets and captures the earnings that were generated from invested capital (assets). ROE measures how profitable a bank is for its owners and represents the ratio of net income over shareholder equity. So, ROA only depends on the ability of assets to generate income, whereas ROE also depends on how these assets are financed (the level of equity and debt). These measures are the most widely used in the literature [4,7,36,70].

SB is a dummy variable that serves to capture sustainable banks. It takes the value of 1 for the banks that have signed the UN Principles for Responsible Banking, and 0 otherwise. Many articles have shown that sustainable banks are more profitable because customers reward socially and environmentally responsible actions [1,5]. Therefore, we expect that the variable SB will have a significant and positive coefficient.

CONC is the market concentration. We used the Herfindahl–Hirschman index (HHI), which is the sum of the squared market share, measured in terms of assets, of all of the banks operating in a market [71–73]. For each country, this index was estimated using all of the banks listed in the S&P Capital IQ database [7,34]. MS is the market share, measured in terms of assets, of bank i at time t [7,35]. XEF and SEF are our measures of efficiency in terms of cost. Cost efficiency is the ratio between the minimum cost at which it is possible to attain a given volume of production and the realized cost. Efficiency ranges over the [0,1] interval, and equals 1 for the best-practice bank in the sample [74]. More precisely, XEF is the cost X-efficiency of bank i at time t. We estimated the Fourier flexible cost function by applying the stochastic frontier approach (SFA) to measure this variable [7,75] (See Appendix A for a description of the procedure for calculating X-efficiency). SEF is the scale efficiency of bank i at time t. We derived the Fourier flexible cost function, with respect to the inputs, to measure this variable [7,76] (See Appendix B for a description of the procedure for calculating scale economies).

To analyze how sustainable banks determine the effects of market power and efficiency on profitability, in Equation (1) we included the interaction terms between the sustainable banks dummy (SB) and the variables CONC, MS, XEF, and SEF (SB × CONC, SB × MS, SB × XEF, and SB × SEF). The effects that CONC had on the profitability of conventional banks (SB = 0) were measured by the coefficient β2. In the case of MS, XEF, and SEF, these effects were captured by the coefficients β4, β6, and β8, respectively. For sustainable banks (SB = 1), the effect of CONC on profitability was measured by the sum of the coefficients (β2 + β3). In the case of MS, XEF, and SEF, this effect was reflected by the sums of the coefficients (β4 + β5), (β6 + β7), and (β8 + β9), respectively.

Conventional banks that operate in more concentrated banking markets or that have a greater market share can obtain non-competitive rents by setting higher prices for customers, so we expect that the coefficients β2 and β4 will have a positive and significant sign [4,31]. Nevertheless, sustainable banks do not normally exploit their greater market share to impose higher prices for clients and their competitive advantage is more based on the emotional factors of their business culture [2,8]. Therefore, the sums of the coefficients (β2 + β3) and (β4 + β5) are expected to be non-significant.

More efficient conventional banks have lower unit costs, so they can attract more customers [4,33]. Therefore, we expect that the coefficients β6 and β8 will have a significant and positive sign. Sustainable practices have both positive and negative effects on efficiency, which is why sustainable banks tend to be as efficient as conventional banks [9,11]. As a result, we expect that the sums of the coefficients (β6 + β7) and (β8 + β9) will have a significant and positive sign also.

EQUITY is the ratio of equity over total assets and serves to capture the risk of insolvency [7]. Banks with lower levels of equity bear higher borrowing costs, which reduces net interest margins and profits [70]. Moreover, banks with higher equity can take advantage of business opportunities more effectively and thus receive a higher return [77]. Therefore, we expect a positive relationship between EQUITY and bank profitability.

The LOANS variable is the ratio of loans to total assets and captures the liquidity risk of the bank and its activity [78,79]. Loans, especially those granted to households and companies, are risky and have a higher expected return than other bank assets such as government securities. Therefore, a positive relationship between LOANS and profitability can be expected [78]. However, another approach suggests that the lower the funds allocated to liquid investments, the higher the profitability obtained [80]. As a result, we can also expect a negative relationship between LOANS and profitability.

SIZE represents the size of the bank and is calculated as the natural logarithm of total assets (deflated) [81,82]. Economies of scale can arise from a larger size, which increases operational efficiency and reduces costs [83]. Therefore, a positive relationship between SIZE and profitability can be expected. Nevertheless, agency costs and bureaucratic expenses tend to be higher in the management of large banks [84]. Consequently, the relationship between SIZE and profitability could also be negative.

ΔGDP represents the Gross Domestic Product (GDP) per capita growth (annual %) and captures the economic cycle [38]. Better economic conditions raise the demand for credit, which boosts bank profitability [77,85]. Therefore, we expect that the GDP growth will have a significant and positive coefficient. Table 3 provides a summary of the independent variables included in Equation (1) and their expected relationships with profitability.

Finally, year- and country-effect dummies were included to capture year- and countryspecific factors. The error term is εi,t, and i = 1, 2, ... , N indicates a specific bank i; t = 1, 2, ... , T indicates a particular year t; and m = 1, 2, ... , M indicates a particular country m. Table 4 presents the descriptive statistics of the variables used in the profitability analysis, and Table 5 depicts the correlation between these variables. The software used to evaluate the statistical parameters and the whole empirical models is STATA (version 12). STATA is a program that enables users to analyze, manage, and produce statistical data, and is primarily used by researchers in the fields of economics, biomedicine, and political science.


**Table 3.** Summary of the independent variables of the profitability analysis.

**Table 4.** Sample statistics of the profitability analysis.


**Table 5.** Correlations of the profitability analysis.


#### 3.2.2. Methodology

The model in Equation (1) was estimated using a two-step System-GMM with robust errors, which is consistent in the presence of any pattern of heteroscedasticity and autocorrelation. This method allows for controlling the problems of endogeneity and delivers consistent and unbiased estimates by using lagged independent variables as instruments [21]. Additionally, the System-GMM estimator provides stronger instruments and lower bias, by considering both first-differenced and levels equations [86]. This methodology is especially useful in samples that are based on a short time scale and a larger number of countries, as it was our case [87,88]. The GDP growth and the year and country dummies were considered exogenous, while the remaining variables were considered endogenous. Based on the Hansen test of the over-identifying restrictions for endogenous variables, in general second

and third lags were used as instruments. The variables EQUITY in levels and CONC in both levels and differences showed over-identification problems according to the Hansen test. To address this issue, we used third lags for the variables EQUITY and CONC (in levels), and fourth lags for the variable CONC (in differences). The exogenous variables were instrumented by themselves.

The large number of endogenous variables in our estimation means that we had many instruments and could inadvertently overfit our endogenous variables. To reduce this possibility, we collapsed the instruments used in our estimation. With the collapse option, one instrument is created for each variable and lag distance, rather than one for each time period, variable, and lag distance. Bowsher [89] found that the use of too many moment conditions can significantly reduce the power of tests of over-identifying restrictions. The collapse option effectively constrains all of the yearly moment conditions to be the same and reduces the instrument count and the number of moment conditions used in the difference-in-Hansen test of exogeneity instrument subsets, which makes this test more powerful [90,91]. Many articles have collapsed the instruments used in the System-GMM estimation [69,92,93].

Finally, we studied each endogenous variable separately to assess whether the instruments provide significant explanatory power over the endogenous variables, focusing on the F-statistics from the first-stage OLS regressions. We ran two different regressions for each endogenous variable: one for the equations in differences (where the instruments are in levels), and the other for the equations in levels (where the instruments are in differences). For the System-GMM regressions, this test is merely indicative of the strength of the instruments since consistency of the GMM estimates relies on the joint estimation of both the levels and the difference equations. Other articles also calculated the F-statistics to analyze the strength of the instruments for System-GMM estimations [92,94,95].

Table 6 shows the results of this analysis. In general, the F-statistics for the first-stage regressions are significant and higher than 10, which is the critical value suggested by Staiger and Stock [96] for assessing instrument strength. It implies that the instruments provide significant explanatory power for the endogenous variables.


**Table 6.** First-stage OLS regressions for System-GMM estimates (profitability analysis).


**Table 6.** *Cont.*

3.2.3. Results of the Profitability Analysis

Table 7 shows the results of the profitability analysis. In Table 7, model (a), we analyzed ROA, and in Table 7, model (b), we examined ROE. In both models the dummy variable SB shows a significant and positive coefficient, so sustainable banks obtain higher levels of profitability.


\*\*\* indicates a level of significance of 0.01, \*\* indicates a level of significance of 0.05, \* indicates a level of significance of 0.1. LR Test. SB × CONC is the linear restriction test of the sum of the coefficients associated with SB and CONC. LR Test. SB × MS is the linear restriction test of the sum of the coefficients associated with SB and MS. LR Test. SB × XEF is the linear restriction test of the sum of the coefficients associated with SB and XEF. LR Test. SB × SEF is the linear restriction test of the sum of the coefficients associated with SB and SEF. CONS is the regression intercept. M2 is the p-value of the 2nd order serial correlation statistic. Hansen is the *p*-value of the over-identifying restriction test.

> The variable CONC, which measures the effects of banking concentration on the profitability of conventional banks (SB = 0), has a significant and positive coefficient in Table 7, models (a) and (b). Therefore, conventional banks that operate in more concentrated markets can exercise effective market power and obtain more profitability, as the market power hypothesis suggests. To capture the effects of concentration on the profitability of sustainable banks (SB = 1), we carried out the linear restriction test of the sum of the coefficient associated with CONC and the coefficient associated with the interaction between SB and CONC (represented in Table 7 by LR Test. SB × CONC). This linear restriction test is not significant in any of the models, which would support our Hypothesis 1.

The variable MS, which measures the effects of market share on the profitability of conventional banks (SB = 0), is significant and positive in Table 7, model (a), but not in Table 7, model (b). Conventional banks with higher market share can probably exercise effective market power and obtain more profits, but this evidence is not conclusive across estimations. In any case, market share does not affect the profits that sustainable banks make because the linear restriction test of the sum of the coefficient associated with MS and the coefficient associated with the interaction between SB and MS (represented in Table 7 by LR Test. SB × MS) is not significant in any of the models.

The variable SEF, which measures the effects of scale efficiency on the profitability of conventional banks (SB = 0), is positive and significant in Table 7, models (a) and (b). Moreover, the LR Test. SB × SEF, which captures the previous effect for sustainable banks (SB = 1), is positive and significant in both models, too. Consequently, banks with better scale efficiency are more profitable, regardless of their sustainable orientation, which would support our Hypothesis 2.

Regarding the control variables, the variable ΔGDP is significant with a positive sign, so the economic growth boosts bank profitability as other studies suggest [77,85]. The variable EQUITY has a significant and positive coefficient in Table 7, model (a), but is not significant in Table 7, model (b), so in our sample, there is no conclusive evidence of the effects of equity on bank profitability.

#### *3.3. Risk Analysis*

3.3.1. Econometric Model of the Risk Analysis

To analyze the relationship between risk and sustainable banking practices, we proposed the following model that is based on the study of Sanfilippo-Azofra et al. [7]:

$$\begin{aligned} \mathbf{Z}\_{\text{i,l}} &= \beta\_0 + \beta\_1 \text{SB}\_{\text{i}} + (\beta\_2 + \beta\_3 \text{SB}\_{\text{i}}) \times \text{CONC}\_{\text{m,l}} + (\beta\_4 + \beta\_5 \text{SB}\_{\text{i}}) \times \text{MS}\_{\text{i,t}} + (\beta\_6 + \beta\_7 \text{SB}\_{\text{i}}) \times \text{XEF}\_{\text{i,l}} + (\beta\_8 + \beta\_9 \text{SB}\_{\text{i}}) \times \text{S}\_{\text{i,t}} \\ & (\beta\_8 + \beta\_9 \text{SB}\_{\text{i}}) \times \text{SEF}\_{\text{i,l}} + \beta\_{10} \text{LOAD}\_{\text{i},\text{I}} + \beta\_{11} \text{SIZE}\_{\text{i,l}} + \beta\_{12} \text{LOAD}\_{\text{i}} \text{ENDEP}\_{\text{i,l}} + \sum\_{t=1}^{T} \text{YEAR}\_{\text{t}} + \\ & \sum\_{\text{m=1}}^{\text{M}} \text{COUNTRY}\_{\text{m}} + \varepsilon\_{\text{i,t}} \end{aligned} \tag{2}$$

The dependent variable (Zi,t) is the Z-score, measured as follows:

$$Z\_{i,t} = (\text{ROA} + \text{K}/\text{A})/\sigma \text{ROA}$$

where ROA is the return on assets, K is the equity capital, A is the total assets, and σROA is the standard deviation of ROA. The Z-score is widely used to measure a bank's risk [7,28,97,98]; the higher the Z-score, the lower the probability of bankruptcy.

As above, SB is a dummy variable that serves to capture sustainable banks. It takes the value of 1 for the banks that have signed the UN Principles for Responsible Banking, and 0 otherwise. Sustainable banks are more transparent and have more stable returns and higher moral standards, and these characteristics allow them to manage risk more effectively [13,28]. As a result, we expect that the variable SB will have a significant and positive coefficient. The variables CONC, MS, XEF, and SEF have the same definitions as in Section 3.2.1.

To analyze how sustainable banks determine the effects of market power and efficiency on risk, in Equation (2) we included the interaction terms between the sustainable banks dummy (SB) and the variables CONC, MS, XEF, and SEF (SB × CONC, SB × MS, SB × XEF, and SB × SEF). The effects that CONC had on the risk of conventional banks (SB = 0) were measured by the coefficient β2. In the case of MS, XEF, and SEF, these effects were captured by the coefficients β4, β6, and β8, respectively. For sustainable banks (SB = 1), the effect of CONC on risk was measured by the sum of the coefficients (β2 + β3). In the case of MS, XEF, and SEF, this effect was reflected by the sums of the coefficients (β4 + β5), (β6 + β7), and (β8 + β9), respectively.

It is not clear what the expected signs of the coefficients β2 and β4 will be, nor the sums of the coefficients (β2 + β3) and (β4 + β5). On the one hand, banks with a larger market share that operate in more concentrated markets can reduce financial instability through the provision of greater capital reserves, which protect them against economic and liquidity shocks [99]. Large banks also have a comparative advantage in monitoring loans and can achieve greater diversification of both the loan portfolio and the geographical distribution [100]. On the other hand, a higher concentration can lead to an increase in interest rates on loans, so borrowers will have to undertake riskier projects to repay their loans [101]. Moreover, banks with a higher market share in concentrated markets are usually more protected by governments, which may lead them to take greater risks [102]. Conversely, more efficient banks tend to become more capitalized, which contributes to bank stability. At the same time, less efficient banks may be tempted to take on higher risks to compensate for increased costs and lost returns [103,104]. As a result, we expect that the coefficients β6 and β8, and the sums of the coefficients (β6 + β7) and (β8 + β9) will have a significant and positive sign.

The variable LOANS is the ratio of loans to total assets and captures the liquidity risk of the bank and its activity [78,79]. Because the variable LOANS represents the liquidity risk of the bank, there should be a negative relationship between LOANS and bank risk [105]. Nevertheless, the loan-to-assets ratio is also an indicator of banks' retail orientation. Retail banks are perceived as less risky than non-retail ones, especially during crises. Additionally, banks with higher levels of loans have a lower proportion of securities, which reduces their exposure to other risks, such as sovereign risk [106]. Therefore, we can also expect a positive and significant relationship between the variable LOANS and bank risk.

SIZE represents the size of the bank and is calculated as the natural logarithm of total assets (deflated) [81,82]. Larger banks are likely to have a higher degree of product and loan diversification than smaller banks, which reduces risk [37]. As a result, we can expect a positive relationship between SIZE and bank risk. However, a negative relationship between these two variables can also be expected because a larger size can lead to reduced efficiency in management, less effective internal control and increased organizational complexity, which can lead to higher operational risk [107].

LOANDEP controls for differences in the intermediation ratio and represents the ratio of loans to deposits [108]. When loans exceed the deposit base, banks face a funding gap for which they must access financial markets. Financial markets are more volatile than retail funding, so we expect a negative relationship between LOANDEP and bank risk [109]. Table 8 provides a summary of the independent variables included in Equation (2) and their expected relationships with risk.


**Table 8.** Summary of the independent variables of the risk analysis.

Finally, year- and country-effect dummies were included to capture year- and countryspecific factors. The error term is εi,t, and i = 1, 2, ... , N indicates a specific bank i; t = 1, 2, ... , T indicates a particular year t; and m = 1, 2, ... , M indicates a particular country m. Table 9 presents the descriptive statistics of the variables used in the risk analysis, and Table 10 depicts the correlation between these variables.


**Table 9.** Sample statistics of the risk analysis.

**Table 10.** Correlations of the risk analysis.


#### 3.3.2. Methodology

Like the profitability analysis, the model in Equation (2) was estimated using two-step System-GMM with robust errors [21]. The year and country dummies were considered exogenous, while the remaining variables were considered endogenous. Based on the Hansen test of the over-identifying restrictions for the endogenous variables, in general second and third lags were used as instruments. To avoid over-identification problems based on the Hansen test, we used third and fourth lags for the variable MS in differences. The exogenous variables were instrumented by themselves. We also collapsed the instruments used in our estimation [92,93]. Moreover, we carried out the F-statistics test to assess instrument strength. These results, which are shown in Table 11, reveal that in general, the instruments provide significant explanatory power for the endogenous variables.

**Table 11.** First-stage OLS regressions for System-GMM estimates (risk analysis).



**Table 11.** *Cont.*

#### 3.3.3. Results of the Risk Analysis

Table 12 shows the results of the risk analysis. Regarding the objective of this analysis, the influence of sustainable banks, the variable SB is not significant, which suggests that sustainable initiatives do not alter bank risk. This does not support our Hypothesis 3.

**Table 12.** Results of the risk analysis.


\* indicates a level of significance of 0.1. LR Test. SB × CONC is the linear restriction test of the sum of the coefficients associated with SB and CONC. LR Test. SB × MS is the linear restriction test of the sum of the coefficients associated with SB and MS. LR Test. SB × XEF is the linear restriction test of the sum of the coefficients associated with SB and XEF. LR Test. SB × SEF is the linear restriction test of the sum of the coefficients associated with SB and SEF. CONS is the regression intercept. M2 is the p-value of the 2nd order serial correlation statistic. Hansen is the p-value of the over-identifying restriction test.

As far as the control variables are concerned, the variable LOANS has a significant and positive coefficient, which denotes that banks with more loans are less exposed to risk [106]. Moreover, the variable SIZE also shows a significant and positive coefficient, so larger banks can achieve greater diversification, which reduces risk [37].

#### *3.4. Discussion*

This article analyses how sustainable practices affect bank profitability, both directly and through the market power and efficiency hypotheses. Moreover, it examines the impact of sustainable banking on insolvency risk.

Firstly, we find that sustainable banks obtain more profits. These results are in line with other studies that suggest that sustainable banks are more profitable than conventional

banks. According to these studies, sustainable banks have a better reputation, provide more confidence, and can attract more loyal customers, which is why they earn superior profits [43,44].

Secondly, conventional banks that operate in more concentrated markets make more profits, as proposed by the market power hypothesis. Nevertheless, for sustainable banks, banking concentration does not affect profitability significantly. These results support the evidence of Matute-Vallejo et al. [8], which suggests that banks do not use sustainability as an attempt to instrumentalize social issues in a manner ultimately intended to increase prices. Instead of taking advantage of their market power to set higher prices for customers, sustainable banks would use other attributes to attract clients and earn profits, such as different business culture, lower reputational risk, or compromise with social and environmental values [2].

Thirdly, banks with superior cost scale efficiency are more profitable, regardless of their sustainable orientation, as the efficiency hypothesis suggest. The positive effects of sustainable strategies on efficiency would compensate for the negative ones and, hence, sustainable banks tend to be as efficient as conventional banks. The findings of many previous studies support this idea. On the one hand, Nidumolu et al. [9] reveal that social and environmental compromises are costly, which can reduce efficiency. On the other hand, as Bassen et al. [11] propose, these compromises can also improve the reputation of the banks that acquire them, which reduces their funding costs. Furthermore, Clarkson et al. [12] show that sustainable initiatives strengthen the sustainable standards of the industry, which raises competitors' costs.

Fourthly, our results show that sustainable banking practices do not have a significant impact on insolvency risk. According to García-Benau et al. [110], the financial crisis seriously damaged the reputation and the confidence of banks, which forced them to implement sustainable strategies despite their risks and costs. This aspect, along with the fact that real sustainability concerns have not emerged until recently, could explain why sustainable banks still do not exhibit lower insolvency risk.

#### **4. Conclusions**

The financial crisis had strongly adverse effects on the image and confidence of the banking sector, which led many banks to implement sustainable business strategies to improve their reputation. These strategies might affect the relationship between market power, efficiency, and profitability, as well as the relationship between sustainable banks and risk. To analyze these changes, we performed an empirical analysis on a sample of 1236 banks from 48 countries over the period 2015–2019. The results of this analysis indicate that sustainable banking practices lead to higher profitability. Moreover, conventional banks that operate in markets with higher concentration are more profitable, as proposed by the market power hypothesis. However, for sustainable banks, market concentration does not affect profits significantly. Higher levels of cost scale efficiency lead to more profitability for both conventional and sustainable banks. There does not appear to be a significant relationship between sustainable banks and risk.

These results have important implications for the implementation of sustainable business models and the research agenda for sustainability in banking. Our results suggest that the traditional determinants of bank profitability are not relevant in explaining the superior profits made by sustainable banks. This suggests the emergence of a new paradigm related to sustainability in the drivers of bank profitability, where intangible competitive advantages such as brand image, customer loyalty, lower reputational risk, or ethical issues could play a key role.

Moreover, sustainable activities still do not affect bank risk, probably because the severe consequences of the financial crisis forced banks to adopt a sustainable approach regardless of their risks. It is possible that sustainable practices will reduce bank risk in the future when banks will have completely restored their image and the confidence lost during the 2008 financial crisis.

On the other hand, our sample includes banks from many world regions with differences in regulation, which could also determine the relationship between sustainability and the market power and efficiency hypotheses, as well as the relationship between sustainability and credit risk. For instance, regulatory factors and legal requirements can have important effects on bank efficiency and solvency. Additionally, legal impediments to competition can alter the degree of concentration. Further research is therefore needed to fully understand the determinants of profitability and risk among sustainable banks, especially in the long run.

**Author Contributions:** Conceptualization, B.T.O., S.S.A., M.C.S.; Methodology, S.S.A.; Software, S.S.A., M.C.S.; Validation, B.T.O., S.S.A., M.C.S.; Formal Analysis, B.T.O., S.S.A.; Investigation, B.T.O., S.S.A., M.C.S.; Resources, B.T.O., M.C.S.; Data Curation, S.S.A., M.C.S.; Writing—Original Draft Preparation, M.C.S.; Writing—Review & Editing, M.C.S.; Visualization, B.T.O., S.S.A., M.C.S.; Supervision, B.T.O., S.S.A.; Project Administration, B.T.O.; Funding Acquisition, B.T.O. All authors have read and agreed to the published version of the manuscript.

**Funding:** This research was funded by the Santander Financial Institute (SANFI), at the University of Cantabria Foundation for Education and Research in the Financial Sector (UCEIF Foundation).

**Data Availability Statement:** S&P Capital IQ database (www.capitaliq.com); International Monetary Fund database (www.imf.org); World Bank´s World Development Indicators (https://databank. worldbank.org).

**Conflicts of Interest:** The authors declare no conflict of interest.

#### **Appendix A**

To estimate cost efficiency, we used the Fourier flexible functional form under the alternative specification. We estimated the efficiency frontier using the stochastic frontier approach (SFA). In addition, we followed the intermediation approach that considers three outputs, three input prices, financial capital (equity) as a correction factor and four environmental variables [7,74,111–113]. We also incorporated the time trend as a measure to control for technological progress [114]. Our specification of the cost function is as follows:

ln(C) = α+ ∑<sup>3</sup> i=1Ξiln(wi) + 1/2∑<sup>3</sup> i=1∑<sup>3</sup> j=1Ξijln(wi)ln(wj) + ∑<sup>3</sup> k=1γkln(yk) + 1/2∑<sup>3</sup> k=1∑<sup>3</sup> n=1γknln(yk)ln(yn) + ωln(E) + 1/2ψln(Ei) <sup>2</sup> + τ1T + 1/2τ2T<sup>2</sup> + ∑<sup>3</sup> i=1∑<sup>3</sup> k=1ρik ln(wi)ln(yk)∑<sup>3</sup> i=1ηiEln(wi)ln(E) + ∑<sup>3</sup> i=1ζiTln(wi) + ∑<sup>3</sup> k=1ρkEln(yk)ln(E) + ∑3 m=1∑<sup>3</sup> k=1ϑkTln(yk) + ∑<sup>4</sup> s=1μkln(vs) + ∑<sup>4</sup> q=1[ϕqcos(xq)+wqsin(xq)] + ∑<sup>4</sup> q=1∑<sup>4</sup> r=1[ϕqrcos(xq + xr) + wqrsin(xq + xr)] + ∑<sup>4</sup> q=1[ϕqqqcos(xq + xq + xq)+wqqqsin(xq + xq + xq)] + lnu + lnε

> The dependent variable is total cost (interest and non-interest expenses). Outputs:

	- Input prices:

Fixed netput:

E = financial capital (equity).

Environmental variables of the country:

	- Time trend:
	- T = time trend.

The variables xq, q = 1, 2, 3, 4 are rescaled values of the variables (lnyk), k = 1, 2, 3, and ln(E) such that xq is in the [0.2π] interval, where π is the number of radians and not the profits. Moreover, we cut 10% off each end of the [0.2π] interval such that the xq span is [0.1 × 2π, 0.9 × 2π]. This eliminates problems of approximation to the extremes. The formula for xq is 0.2π − μ × a + μ × variable, where μ ≡ (0.9 × 2π − 0.1 × 2π)/(b − a), and [a, b] is the range of the variable.

Because the duality theorem requires that the cost function is linearly homogeneous in input prices and continuity requires that the second-order parameters are symmetric, the following restrictions apply to the parameters:

$$\sum^3 \mathbf{i} = 1 \,\text{!} \,\text{>}\,\text{=} 1; \,\sum^3 \mathbf{i} = 1 \,\text{!} \,\text{>}\,\text{=} 0; \,\sum^3 \mathbf{i} = 1 \,\text{!}\,\text{=} 1 \,\text{=} \,\text{!}\,\text{=} 1 \,\text{=} \,\text{!}\,\text{=} \,\text{=} 0$$

The inefficiency term is assumed to be distributed as half-normal.

$$
\mathcal{G}\_{\mathbf{i}\mathbf{j}} = \mathcal{G}\_{\mathbf{j}\mathbf{i}} ; \mathbf{\gamma}\_{\mathbf{i}\mathbf{k}} = \mathbf{\gamma}\_{\mathbf{k}\mathbf{i}}
$$

#### **Appendix B**

We estimated the scale economies by deriving the cost function with respect to the inputs:

$$\text{SCALE} = \sum\_{\text{n=1}}^{3} (\delta \ln \text{C} / \delta \ln \text{y}\_{\text{i}})$$

This measure was calculated with the mean of the input and output values in various size classes [7,76] and for each of the years analyzed. We considered six intervals: (1) less than \$500 m; (2) between \$500 m and \$1 bn; (3) between \$1 bn and \$3 bn; (4) between \$3 bn and \$5 bn; (5) between \$5 bn and \$10 bn; and (6) more than \$10 bn.

A bank operates under increasing, constant, or decreasing returns to scale when this measure is greater than, equal to, or less than 1, respectively.

#### **References**

