The mediating role of ESG on the interaction between green banking and financial performance of commercial banks in Kenya

Green banking practice involves the bank's internal operations, external operations and lending decisions which are environmentally, socially and governance (ESG) compliant and sustainable. In Kenya, green banking practice is influenced internally and externally and is context based. Adverse weather patterns such as drought and floods have recently influenced income in sectors such as agriculture, transport and manufacturing. The adverse effects have affected GDP and livelihoods and as a trickle down influenced savings and investments. From the year 2012, conversation on sustainable financial institution was tabled through a CEO round table targeting players in the banking sector. The aim was to transform the banking industry to be more resilient and sustainable. One way of greening the banking sector was by embracing green banking practices and incorporating ESG in banks' processes and products. This paper aims to investigate how green banking interacts with ESG performance to shape the financial outcomes of commercial banks in Kenya. The paper looks at profitability assessed through ROA and credit risk assessed through NPLs. Anchored on the stakeholder theory, the resource-based view theory and the institutional theory, the paper goes further to test the role of ESG as a mediator on the interaction between green banking and financial performance of commercial banks in Kenya. The paper uses panel data collected from commercial banks in Kenya. Secondary data on GBI, ESG and financial performance was collected for a period of 13 years. ESG and GBI measures were obtained, measured and scored using existing literature. The study analysed a total of 25 commercial banks applying balanced panel data regression with firm fixed effects and controls per year. Mediation analysis was used to test the indirect effect of green banking (independent variable) on financial performance (dependent variable) through the mediating variable (ESG). The findings of the study indicate that green banking positively influences financial performance The findings also indicate that green banking reduces credit risk. As a mediator, ESG shows a statistically strong association with green banking. However, from the mediator, there is a limited mediating effect on performance and risk. The findings indicate that as commercial banks embrace ESG practices, they become greener and this has a positive and statistically significant relationship with financial performance. Therefore, this paper aims at proposing measures that policy makers and banks as heads of the supply chain can adopt in driving climate risk mitigation and adaptation, and incorporating ESG in banking practice, while safeguarding financial performance. The paper encourages commercial banks to embrace green banking and ESG practices in order to draw short term, medium term and long-term benefits that accrue.