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Risk-taking channel of monetary policy and the role of ESG and political instability: evidence from South Asia

Author

Listed:
  • Khalil Ullah Mohammad

    (Bahria Business School, Bahria University)

  • Muhammad Mazhar Hussain

    (Kobe University)

  • Noor Ul Haya Adnan

    (Foundation University)

Abstract

Purpose This study explores the impact of monetary policy on the risk-taking behavior of financial institutions in South Asia and examines how sustainability, social responsibility, and good governance concerns moderate this transmission channel’s effectiveness. Method We apply a two-step difference generalized methods of moments (diff-GMM) using quarterly bank-level data from South Asia to test the impact of monetary policy on risk-taking behavior. We use the real interest and monetary policy rates as proxies for the monetary policy stance. Political instability and environmental, social, and governance (ESG) scores are used to proxy good governance and ESG concerns. Findings We find evidence of the risk-taking channel of monetary policy in South Asian countries, supporting the search for yield hypothesis. Higher ESG scores inhibit credit risk-taking, while poor governance, proxied by higher political instability, exacerbates bank risk-taking. Improved ESG scores, political stability, better leverage ratios, and operational efficiency weaken the size of the risk-taking channel. Better capitalization and earning quality are found to be insignificant when moderating the channel. Significance Monetary policy research in South Asia remains underexplored, highlighting a gap in understanding regional financial dynamics. This study addresses this gap by examining the impact of monetary policy on the risk-taking behavior of financial institutions in South Asia. Furthermore, the rising awareness of ESG reporting over the past decade indicates a shift towards integrating sustainability into financial practices. By investigating how ESG concerns moderate the effectiveness of monetary policy transmission, this research provides valuable insights for policymakers aiming to balance economic growth with financial stability.

Suggested Citation

  • Khalil Ullah Mohammad & Muhammad Mazhar Hussain & Noor Ul Haya Adnan, 2025. "Risk-taking channel of monetary policy and the role of ESG and political instability: evidence from South Asia," International Economics and Economic Policy, Springer, vol. 22(3), pages 1-25, July.
    • Handle: RePEc:kap:iecepo:v:22:y:2025:i:3:d:10.1007_s10368-025-00674-8
    DOI: 10.1007/s10368-025-00674-8
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