Muhammed Veysel Kaya, Şeyda Yıldız Ertuğrul
This paper investigates the effect of Environmental, Social and Governance (ESG) scores and Credit Default Swap (CDS) spreads on the profitability of Halkbank, one of the biggest state-owned banks in Türkiye, an emerging economy. To this end, we employ Non-linear Autoregressive Distributed Lag (NARDL) and Markov Switching Regression (MSR) methods, taking into account non-linear market risks, using Halkbank’s quarterly data consisting of 63 observations for the period 2009Q1–2024Q3. Moreover, to prevent multicollinearity, we aggregate banking-specific and macroeconomic indicators into a single composite index using Principal Component Analysis (PCA). Our MSR findings suggest that ESG scores and CDS spreads negatively affect bank profitability and that these effects are particularly pronounced during periods of high market volatility. Similarly, NARDL findings suggest that ESG scores have asymmetric effects on bank performance, with both positive and negative changes in ESG performance having a negative impact on profitability, and moreover, negative changes have a more negative impact on profitability. This means that the bank’s sustainability initiatives may be costly and negatively affect profitability in the short run, but these effects will be more negative if initiatives deteriorate. Our findings emphasize the need for banks to adopt a gradual ESG approach that enables them to increase their capacity without compromising financial stability and for regulatory structures to have a flexible and sophisticated risk management framework capable of rapidly adapting to different market conditions. Therefore, our study provides valuable insights to sector managers and policymakers regarding the financial implications of sustainability approaches.