The Nexus Between ESG Scores and Financial Performance in Islamic Banking Sector

Abstract

In recent years, the relationship between Environmental, Social, and Governance (ESG) scores and financial performance has garnered increasing scholarly attention. However, the Islamic banking sector remains underexplored in this context. This study addresses this gap by investigating the impact of ESG scores on the financial performance of Islamic banks globally, financial performance is measured using return on assets (ROA) and return on equity (ROE), while ESG scores are analysed as distinct independent variables to assess their individual effects. Utilizing data from the Refinitiv Eikon Thomson Reuters database, the study employs panel data analysis over an annual timeframe. The findings reveal that ESG scores have a positive and statistically significant impact on ROA, indicating a strong correlation between ESG practices and long-term asset efficiency. However, no significant relationship is found between ESG scores and ROE, suggesting that sustainability initiatives may not directly enhance short-term profitability. Further analysis shows that environmental performance has no significant effect on financial outcomes, while social performance yields mixed results, occasionally exhibiting significant but inconsistent effects on long-term performance. Notably, governance emerges as the most influential ESG component, playing a critical role in driving long-term efficiency and risk mitigation. These findings carry important implications for decision-makers, investors, and stakeholders in the banking industry, particularly in the MENA and Southeast Asian regions. The study underscores the need to prioritize governance enhancements—such as increasing transparency in decision-making and strengthening compliance frameworks—as these measures consistently contribute to improved ROA. Overall, the results highlight the pivotal role of strong governance structures in ensuring sustainable financial performance within the Islamic banking sector.