The impact of share buybacks and ESG principles on banks

In recent years, the theoretical debate surrounding responsible corporate behaviour has expanded beyond financial performance to encompass environmental sustainability, social responsibility, and robust governance practices. This holistic framework, commonly referred to as Environmental, Social, and Governance (ESG), has gained significant importance among investors, regulators, and stakeholders as a means to evaluate a company's long-term sustainability and social impact. While ESG considerations have predominantly focused on industries such as energy, manufacturing, and technology, the banking sector, as a crucial pillar of the global economy considering that it allocates financial resources to the economy, is increasingly under scrutiny for its role in promoting sustainable and ethical practices. One additional specific aspect of banking operations that has attracted considerable attention over the last years is the practice of share buybacks. Share buybacks involve a company repurchasing its own outstanding shares from the open market, thereby reducing the number of shares available for trading. This mechanism has gained popularity among banks as a tool to return surplus capital to shareholders, enhance earnings per share, and potentially improve stock prices. This study focuses on both share buybacks in banks as well as on climate risk stress tests in the banking sector thereby covering two of the three aspects related to ESG principles, environment and corporate governance. More specifically, the first paper whose focus is on the current banking regulatory framework governing ESG principles in the EU, seeks to provide an overview of the regulations currently in place aimed at facilitating the introduction of the ESG principles in the banking processes. Delving on the environmental aspect of the ESG principles, the second paper seeks to lay down a comprehensive framework for climate risk stress tests in the banking sector. One important aspect to notice is that the pursuit of the objective of facilitating a transition to a greener economy, that is also part of the ESG principles, could sometimes be at odds with the prudential nature of the banking regulatory framework. Banks’ exposure should, in fact, be classified from a prudential perspective based on their riskiness (i.e. risk sensitive framework) that could be potentially unrelated from their “greenness” (as there is no sufficient data to prove the lower riskiness of greener assets). This specific characteristic, risk-sensitive nature of the framework, has been underscored also in a recent EBA report “the role of environmental and social risks in the prudential framework”. In this vein, by focusing on a risk-based approach and leveraging on the current data available, the second paper aims at laying down a methodologically robust comprehensive prudential framework for climate risk stress tests in banks. Shifting the attention to the corporate governance aspect of the ESG principles, the paper on share repurchases seeks to provide a comprehensive analysis of how these repurchase programs could potentially negatively impact the long-term value creation in banks. As a matter of fact, share buybacks could potentially undermine the resilience of banks by leading to a potential depletion of their capital position in the long term. Therefore, the incorporation of the ESG principles into the banking operations as a tool to improve the transparency of the decision-making process could help avoid the adoption of detrimental decisions that could threaten the resilience of the bank in the long term. Furthermore, by focusing on share buybacks and ESG principles, the study aims at further unveiling potential links between these two relevant aspects widely debated in the financial literature. The common denominator of the three papers is the need to ensure the resilience of the banking system, by testing the robustness of the capital positions of banks to climate risks and by preventing the abuse of share buybacks programs to the detriment of the long-term value creation, while promoting the incorporation of the ESG principles into the banking processes. Throughout this work, we will try to find an answer to several key questions: How do share buybacks impact a bank's long-term value creation? To this extent, what are the implications of share buybacks on the wider audience of stakeholders? Furthermore, what role do share buybacks play in shaping a bank's governance structure, transparency, and risk management practices? To answer these questions, we will draw on a comprehensive review of existing literature as well as empirical evidence of share buybacks in the banking sector. By analysing the potential trade-offs and synergies between short-term financial gains and long-term sustainable practices, we aim to contribute to the ongoing dialogue surrounding responsible banking. We will then focus the attention on the current banking regulatory framework on ESG principles. The authors believe that the incorporation of such principles into the banking processes could be an effective tool to improve the decision-making process in banks. This research endeavours to provide insights that can inform regulatory frameworks, guide investor strategies, and empower banking institutions to adopt a more transparent decision-making process as well as more sustainable and socially responsible practices. By recognizing the multifaceted nature of banking operations, we can pave the way for a more resilient and inclusive financial sector that aligns its activities with the broader goals of environmental stewardship, social progress, and robust governance.