Abdullah Aldousari, Mariam Alsabah
Sustainability initiatives have gained significant attention; however, limited research has examined whether ESG factors facilitate or hinder financial sector efficiency. This research investigates the differences between the traditional stochastic frontier analysis (SFA) and the ESG-integrated SFA model in explaining inefficiency. In addition, it examines how ESG factors influence inefficiencies in a truncated regression. The sample includes 9 banks (4 Islamic and 5 commercial) and 11 financial firms—all the ESG adopters in Kuwait financial sector. Quarterly data were employed from 2018 to 2023. The findings revealed that the ESG-integrated model improves the explanatory power of the cost function, partially reducing stochastic noise in financial operations. Moreover, ESG facilitates lending consistently and reduces the marginal cost of non-interest activities. Nonetheless, capital reliance in both models is associated with higher inefficiencies. Additionally, we found that financial institutions on average operate at 33% below the best-practice technology frontier, indicating moderate gaps across the sector. Overall, strong ESG alignment is associated with improved cost-efficiency when supported by strong institutional quality.