The legal system in the nexus between ESG and banking risk

The article examines the implications of the legal context in the relationship between ESG and the financial risk of 461 banks operating in common-law economies and 120 banks operating in civil-law economies between 2010 and 2024. Using a system-generalized method of moments (GMM), the results show that ESG performance and its components each impact bank stability differently across financial systems. In common-law (market-based) economies, environmental initiatives reduce stability and market value, while governance and social efforts have mixed effects. In civil-law (bank-based) economies, ESG—especially environmental and governance practices—enhances stability and reduces credit and liquidity risks. These results suggest that ESG integration has a stronger and more direct impact on financial performance in bank-based systems compared to market-based systems. Because ESG affects bank stability differently in common‑law and civil‑law systems, regulators should tailor sustainable‑finance rules to their legal context: in civil‑law (bank‑based) systems, policies can confidently strengthen mandatory ESG integration to reduce credit and liquidity risks, whereas in common‑law (market‑based) systems, policymakers should focus on incentivizing governance and social practices while designing environmental requirements carefully to avoid short‑term destabilizing effects.