THE IMPACT OF GREEN BANKING PRACTICES ON BANKS’

COST OF CAPITAL; EVIDENCE FROM A DEVELOPING

COUNTRY
Received: 24 September 2024
Revised: 21 December 2024
Accepted: 07 January 2025 Rabiya Imran
Published: 20 January 2025 Department of Management Science, COMSATS University Islamabad, Wah
Campus. Wah Cantt. Pakistan
Majid Jamal Khan
Department of Management Science, COMSATS University Islamabad, Wah
Campus. Wah Cantt. Pakistan
Corresponding Email: [email protected]
Shahab ud Din
Department of Management Science, Karakoram International University,
Ghizer Campus, Gilgit-Baltistan. Pakistan

ABSTRACT
Purpose: This study aims to explore whether green banking practices by Pakistani
banks have any impact on their cost of equity and cost of debt.
Design/Methodology: We constructed a specifically designed composite green
banking index to measure the extent of green banking practices from banks within

NBR the sample. Cost of capital is represented by the cost of debt and cost of equity. Banks
listed on Pakistan’s KSE-100 Index over a period of the 10 years i.e. from 2010 to 2019
NUST Business Review is used as our study sample. Panel Data Regression analysis is used to test the
ID: NBR24092401 hypothesized relationships.
Vol. 06 (02) Findings: Green banking is still in its evolution phase among Pakistani banks. While
01, 2025
the debt market is stricter and is incorporating these practices in advancing financing
pp. 41-71
to the banks, there is still a need for investor education and awareness at the equity
DOI:
10.37435/nbr.v6i2.89 market level, which has not yet been incorporated in the pricing of the banking stocks.
This work is licensed Originality: Green banking is still in its evolution phase among Pakistani banks.
under a Creative
Commons Attribution
While the debt market is stricter and is incorporating these practices in advancing
4.0 International financing to the banks, there is still a need for investor education and awareness at
License.
the equity market level, which has not yet been incorporated in the pricing of the
banking stocks.
Keywords: Green Banking; Cost of Capital; Cost of Equity; Cost of Debt; Environment
Paper type: Research Paper

41
INTRODUCTION
One of the significant predicaments faced by mankind at this time is a surge in the
degradation of the environment and natural resources. Unsustainable human
activities are the main contributor towards this alarming environmental trend
(Bukhari, Hashim, & Amran, 2019). Nevertheless, preservation of the environment
remained a foremost problem in many countries (Julia & Kassim, 2019).
Like any other major sector of the economy, the financial system is getting affected by
climate change because of its great influence across all the fields and geographies, and
the high level of confidence that there will be risk involved with irrevocable effects
(Park & Kim, 2020).
Many banks have started financing green projects but still, the vast majority of banks
have a low green portfolio. The lack of regulatory policies and supervisory framework
is evident. The integration of environment related risks and climate change, into the
bank’s risk management system has failed brutally (Park & Kim, 2020). Volz (2017)
expressed that several central banks around the world in response to the absence of a
properly regulatory system and supervisory framework are becoming aware of their
part in considering climate change and environmental risk and are ready to take
action against it.
Pakistan comes under the top 10 countries that are most adversely affected by climate
change according to the German Watch report (2020). The federal government of
Pakistan established a Ministry of Climate Change which was active in framing the
National Climate Change Policy 2012. The provinces too have passed their
environmental protection laws in compliance with the Federal Environmental
Protection Act, 1997 (Hasnain, Aly, Ishfaq, & Afgan, 2017) .
Recent studies have empirical findings regarding the adverse impacts of climate
change on various sectors of the Pakistani economy. Notably, according to Wahab et
al., (2023) climate change has had a significant negative impact on the agricultural
sector. Further, this fall in agricultural productivity has not only resulted in
agricultural loan defaults but has also affected the overall financial stability of the
banking sector in Pakistan (Wahab, Khan & Khan 2022). The banking sector is
therefore more vulnerable as well as equally responsive now to environmental
concerns. According to Javeria, Siddiqui, and Rasheed (2019) and SBP concept paper
(SBP 2015) that CSR, environmental concerns, sustainability, and economic gains are
the most important reasons for the banks in Pakistan to adopt Green banking. The
degradation of the environment, being socially irresponsible, and poor governance
will only lead to reactions by the public, investors and customers, and apart from this,
it will make the regulations more strict and severe which can cause harm to the
profitability of the bank restraining the market for the products of their clients.
Furthermore, the financers can be held accountable for the environmental impacts
caused by their clients (Ahmed, 2012). Therefore, banks have strong motives to be
green. The increasing focus on environment related activities of the banks by the

42
credit rating agencies and investors might have an impact on the way they price their
securities in the capital market, affecting in turn their cost of capital.
One of the most important sources of financing industrial projects is the banking
industry, which leads to utmost carbon emission. Hence, an intermediary role is
played by the banking industry between economic growth and environmental
conversation, by promoting environmentally friendly and socially responsible
investment. To help in the reduction of carbon emissions the banks should invest in
environment-friendly projects. It is observed that the performance of the banks
enhances after the adoption of green banking policies, they are doing better in the
context of valuation, profit/loss, and ROE. Green banking is a new concept, whose
main purpose is to reduce carbon footprints and benefit the environment by
promoting environmentally friendly practices.
Banks are increasingly switching to green banking due to two reasons:
1. Regulatory pressure because increased regulations, ranking and rating
agencies are emphasizing it.
2. Competitive pressure arising from a competitor bank adopting green
practices.

Taking into consideration this whole background, the objective if this work is to
analyze whether the investors in the Pakistan stock market incorporate green
practices into their pricing of the banks stock prices. To be specific, we will explore
the impact of adopting green banking practcies on banks cost of capital in a sample
of Pakistani listed banks.
The rest of the paper is organized as follows; Section 2 presents a theoritical
framework detailing the connections of this work to relevant established theories,
Section 3 discusses critical review of previous related research literature, Data, sample
and econometric methodology is covered in Section 4, results and
interpretations/discussions of the findings are presented in Section 5, while Section 6
concludes the paper.

THEORATICAL FRAMWORK
The capital structure's theoretical foundation was established by Modigliani and
Miller (1958) work, known as the capital structure irrelevance theorem. According to
this, a company's value would not be influenced by its capital structure in a perfect
market. Regarding the financing structure for sustainable development, this could
imply that businesses will choose to use green bonds for debt capitalization as long
as they stand to gain more than they lose—for instance, when these instruments
provide lower-cost funds or greater access to investors, among other benefits (B.
Zhang & Wang, 2021). Myers (1984) Developed the pecking order theory, which states
that managers may rely more on internal funding than on outside sources when there
is a lack of transparency between investors and administrators. Regarding green
financing, this could be made worse by an information asymmetry brought on by the
intricate and innovative nature of green projects, which Zhou, Tang, and Zhang (2020)

43
call the "green information gap." Because these projects are complex and
unprecedented, businesses may find it more difficult to obtain outside funding for
their green initiatives. This further supports the applicability of pecking order theory
in the green finance area, as further explained by (Ibrahim, Al-mulali, Ozturk, Bello,
& Raimi, 2022). As per the financial model of the pecking order theory the debt is
favored over equity and the corporations would choose to issue debt rather than
equity to mitigate the information asymmetry and information cost.
Corporations can now access green funding including green bonds and sustainability-
linked credits. The reason for this is that investors are increasingly considering
environmental, social, and governance (ESG) factors when making investment
decisions, a trend known as ESG investing (Friede, Busch, & Bassen, 2015). One effect
of increasing ESG investments, is that it makes it possible for businesses to engage in
sustainable finance through green bonds and sustainability-linked loans(Wu, Wen,
Tian, & Xiao, 2024).
The Stakeholder theory
The stakeholder theory was introduced by Freeman (2010), which helps to
understand that how the organization engages and manages the connection with
numerous stakeholders beyond shareholders such as employees, consumers, vendors
and the community (Mahajan, Lim, Sareen, Kumar, & Panwar, 2023). In relation to
green banking, the stakeholder theory examines how green banking initiatives
influences the perspective and behavior of employees, customers and larger
community (Ye & Dela, 2023). This theory acknowledges the relation between banks
and their stakeholders, offers an extensive structure to comprehend how green
finance initiatives change the banks image and goodwill while supporting social
responsibility ideals.
Legitimacy theory
The legitimacy theory refers to organizations adoptability and compliance with the
legislations and policies that applies in its operating environment (Nurmalia, 2021).
Complying with societal standards is essential for the financial sustainability of the
organization (Deegan, Rankin, & Tobin, 2002; Siregar & Tampubolon, 2019). This is
implemented to establish trust, as the community provides financial resources for the
company. On the other hand, Socially Responsible Investment theory (SRI) is
influenced by ethical investment principles, anchored by numerous belief system
(Chatzitheodorou, Skouloudis, Evangelinos, & Nikolaou, 2019). These two theories
help to understand the three dimensions which include social, environmental and
sustainability.
Green banking strategies is one of the ways that organizations adopts to make their
environmental sustainability performances better. The need for the natural
environment have impacted the lives of the employees which has become tough for
the businesses to ensure the wellbeing of its employees (like water, transportation,
cooling/heating etc.) to get maximum production from the workforce (DuBois &
Dubois, 2012). The declaration about the green banking to the stakeholders reveals a
lot to them about the banks commitments, endeavors and quality with regards to
44
environmental responsibility, which decreases the disparity of the information and
increase transparency (Khan, Bose, Sheehy, & Quazi, 2021). Green Banking
declaration enhances the goodwill and authenticity of the banks which benefits them
by achieving financial goals (Qirem et al., 2023; Yunidwi & Napitupulu, 2024)
The theories suggest that the establishment of capital structure is motivated by several
factors.
LITERATURE REVIEW
Climate resilience is the most complex issue the world is facing. There have been
relentless attempts worldwide to measure and reduce the threat of climate
destabilization due to human activities (Bhardwaj & Malhotra, 2013). A Ministry of
Climate Change was established by the Federal Government of Pakistan which was
useful in articulating National Climate Chang. This included further rules and
regulations for the protection of the environment to mitigate toxic pollution (Hasnain
et al., 2017). This invited the idea of green banking which aims to diminish the carbon
footprints of the banks (Ahuja, 2015). Over the last decades, banks have been
considered eco-friendly. But with time it was realized that banking activities do affect
the environment both directly and indirectly (Bukhari et al., 2019). The shareholders
have also pressurized the banks to function in an eco-friendly way (Sahoo & Nayak,
2007).
Although the banks were never seen as a polluting industry, their current banking
activities have given a rise to carbon footprints of banks because of their maximum
utilization of energy, high wastage of paper, absence of green building, etc. Such
procedures, technologies and products should be chosen by the banks, which will
minimize the carbon footprints and will develop a sustainable business (Bhardwaj &
Malhotra, 2013). A banking activity that helps in reducing external carbon emissions
by funding green technologies and projects which help in the reduction of pollution
is called green banking (Meena, 2013). According to Bihari (2011) social responsibility
is promoted via green banking. The banks finance those projects which are
environmentally friendly. The objective of the bank is shifted from “profit only” to
“profit with responsibility”.
In emerging economies, banks are viewed as the major source of financing the
industries (Rehman et al., 2021). SM Mahfuzur and Barua (2016) Said that banks
should perform an insightful part to bind enterprises to use environmentally friendly
technologies. Therefore, banks can perform as ethical corporations by providing loans
to those industries which are concerned about the environment.Following the
International Institute for sustainable development, the incorporation of sustainable
growth into the banking industry has two basic points: (1) track down the social and
environmental responsibility into the activities of the banks using environmental
initiatives and (2) inclusion of sustainability into the core activities of the bank by
considering the inclusion of environmental and social consciences into product
development, mission strategy, and policies (Tu & Dung, 2017).

45
The green finance market can be described as “a credit intermediary of environmental
protection’s capital” (Gilchrist, Yu, & Zhong, 2021). The market of green finance
comprises of market-based mechanisms and financial tools which can control the
pollution discharge, comprehend the ecosystem and prevent enterprises from sudden
nature changes (Wang & Zhi, 2016). According to Bukhari, Hashim, and Amran (2020)
embracing green banking can safeguard the banks from various types of risk for
example; credit default, the risk to the reputation of the banks, legal risk, and risk to
the environment. (Lymperopoulos, Chaniotakis, and Soureli (2012)) Also expressed
that the improved effectiveness of the operations and enhanced brand identity due to
the adoption of green banking will give rise to the market share, better staff
participation, profitability, and boost social and economic authenticity in favor of the
banks.
The association between a firm’s environmental practices and the value of its stock
has been long documented in extant literature. For example a moderate to strong
relationship between the value of the common share of a company and its social
performance regarding environmental risk was found by (Spicer, 1978). Later,
Richardson and Welker (2001) tested the association for a sample of Canadian firms
between financial and social disclosure and the cost of capital and the results showed
that there is an inverse relationship between the quality and quantity of the financial
disclosure and the cost of capital. It is essential for the banking industries to execute
the concept of green banking because they are the major source of providing loans to
the companies and while also mitigating the negative environmental effect of their
operations. This study by Jelli and Dura (2024) used quantitative approach, drawing
on secondary data from financial statements and sustainability reports. The method
used was classical assumption test, F test and T test on the population comprises of
57 industries and a sample of 40 companies. The T test results show a positive impact
of green banking on return on assets while there is a negative impact on return on
assets of operational costs to operating income (BOPO). Based on the F test the return
on assets is influenced by green banking and BOPO.
Another research aims to recognize the influence of green banking practices on green
finance and environmental performances of the banks in Bangladesh along with
investigating the mediating role of green finance regarding the association between
the green banking activities and environmental performances. The convenience
sampling technique was used to collect the firsthand data with the final sample size
of 352 was documented from the banks in Bangladesh. Structural equation modeling
(SEM) was used to evaluate the relationship amongst the variables. The results
showed that sources of green financing have a considerable impact on banks'
environmental performance, and that green banking operations have a significantly
positive impact on banks' environmental performance and sources of green financing.
Furthermore, it is noticed that the relationship between green banking activities and
environmental performance is mediated by green financing. Additionally, the study
found that the major perks of green banking development are elevating banks'
competitiveness, lowering long-term costs and expenses, offering online banking,

46
enhancing customer satisfaction, and lowering carbon footprints. All of these factors
contribute to the nation's sustainable economic development (X. Zhang, Wang,
Zhong, Yang, & Siddik, 2022).
According to Ramnarain and Pillay (2016) the five most important benefits for green
banks were proposed by Global Systemically Important Financial Institution (GSIFIs).
Advantages include having healthier clients’ coverage relating to attracting deposits
and providing loans, which ultimately results in increased growth in income and
assets and will give better returns on assets. Papastergiou and Blanas (2011) Shows
various useful reasons that why green eco-friendly banking structure is followed by
more banks; for instance, green banks have greater repute and branding, it also
enhanced the quality of the portfolio of the banks and lessened the liability insurance
and compensation allege. Earnhart and Lizal (2007) evaluated the effect of
environmental performance on cost and revenue and the outcome showed that
healthier environmental performance will improve profitability through cost
reduction than driving down revenues.
Auwa, Syamni, and Muchtar (2024) examined the influence of profit quality,
intellectual capital and green banking on the value of banking firms as measured by
Price to Book Value (PBV) from the period of 2018-2022 in banks listed on Indonesia
stock exchange. The sample size consists of 42 companies and the research used panel
data regression analysis method. The results show that green banking is negatively
associated with the firm value. On the other hand, no relation can be seen between
the profits, intellectual capital with firm value. Similarly, in another research the
influence of green banking and financial performances on profitability was examined.
Thirty samples were chosen for this research using a purposive selection technique
from six banking businesses that were listed on the Indonesia Stock Exchange from
the period of 2028-2022. Panel data regression analysis was used, and the results
depict profitability is negatively affected by capital adequacy ratio and efficiency
ratio, on contrary it has a positively associated with non-performing loans and the
loan to deposit ratio. Also green banking disclosure relation with profitability is
significantly negative (Walzer, Tamimi, & Firmansyah, 2024).
Pakistan comes under the top 10 countries that are most adversely affected by climate
change. The CO2 emissions by Pakistan are much higher than the less advanced
SAARC countries but are lesser than the Himalayan slope states (Abas, Kalair, Khan,
& Kalair, 2017). The parameters of drinking water set by WHO are often dishonored
(Azizullah, Khattak, Richter, & Häder, 2011). Imran, Haydar, Kim, Awan, and Bhatti
(2017) Found that Pakistan is also a target for the E-waste of the developed countries.
E-waste includes numerous forms of metal. They also said that recycling activities by
informal sectors does not consider the contamination of the environment and is also
hazardous for individual health.
The state bank of Pakistan launched the green banking guidelines in October 2017 to
lessen the exposure of the banks from the risks emerging from the environment. The
Ministry of Climate Change of Pakistan introduced further environmental rules and
regulations to mitigate and control pollution and other destructive acts (Hasnain et

47
al., 2017). Jafar, Malik, Azhar, and Shafiq (2021) stated that adoption of green banking
practices in daily operations minimized energy consumption usage and encourages
e-banking practices to reduce operational costs (Shaumya & Arulrajah, 2016). A study
was conducted by Ikram, Zhou, Shah, and Liu (2019) on 211 manufacturing
companies of Pakistan that either the compliance of environmental management
system (EMS) with integrated management system (IMS) will enhance corporate
sustainability or not, the results disclosed that corporate sustainability performance
of the companies who adopted EMS is a lot better than the companies who didn’t.
Based on the above literature, many studies have been carried out related to this field,
mostly using different aspects of green banking. It becomes apparent that only a few
studies are carried out in this field in Pakistan. In this regard, there is a need to
examine green banking practices in Pakistan and their impact on the cost of capital of
the banks. Therefore, this investigation was initiated in the context of Pakistan to fill
the research gap.

METHODS
Data and Sample
The sample for this study comprised banks listed on the Pakistan Stock Exchange over
a period of 10 years i.e. from 2010-to 2019. The data was collected using the annual
reports of all the banks and their websites each year. We started our sample period in
2010 as green banking practices were less common in Pakistan before 2010. Further,
we ended our sample period in 2019 as we believed including 2020 and 2021 may add
noise to our findings due to the exceptional impacts of COVID-19 during these years.
We included in our sample, those Pakistani listed commercial banks that:
1) Had continuous stock price data for at least three consecutive years to allow
calculations of the cost of equity.
2) Had annual reports available for at least three consecutive years to be able to
calculate their Green Banking scores.
3) Had information in their annual reports on their Green Banking practices.

After applying this rigorous sample selection criteria and then cleaning the data for
extreme values, our final sample comprised of 20 banks with 175 Bank-Year
observations. The number of banks in Pakistan are limited and because of this
minimal ratio, selecting 20 banks is a considerable share of the whole market which
still capture a significant insight. As State bank of Pakistan issued its green banking
guidelines in 2017, the sample includes the banks who have adopted green banking
practices and were working their way towards sustainability even before green
banking was introduced in Pakistan. Also, not all the banks have complete or reliable
data overall, so the focus was on the banks with complete datasets. Furthermore, for
a thorough and meticulous analysis of each bank a smaller sample size was more
suitable.

48
Model
Our data set is panel having several years and several entities while static panel data
estimation models with fixed or random effects regression is applied. The following
equation describes our model:
𝐶𝑂𝐶𝑖𝑡 = αₒ + 𝛽₁𝐺𝐵𝑎𝑛𝑘𝑖𝑛𝑔𝑖𝑡−1 + 𝛽2 𝐷𝑖𝑣𝑃𝑖𝑡−1 + 𝛽3 𝐹𝑖𝑟𝑚𝑆𝑖𝑡−1 + 𝛽4 𝐶𝑎𝑝𝑡𝑆𝑖𝑡−1
+ 𝛽5 𝑃𝑟𝑜𝑓𝑡𝑖𝑡−1 + 𝛽6 𝐵𝑆𝑖𝑧𝑒𝑖𝑡−1 + 𝛽7 𝐵𝐼𝑛𝑑𝑖𝑡−1
+ ϵ ___________________________________________(1)
The details of the variables used in the above model are summarized in Table 1 below.
Table 1:List of Variables and Measurements

Variables Code Measure

Dividend Payments DivP Dividend paid divided by net
income
Firm Size FirmS Ln of Deposits
Capital Structure CaptS Total Liabilities by Total Assets

Board Size Bsize Total number of members on

the board of directors

Board Independence Bind Ratio of non-executive

members on the directors’
board divided by total No, of
members on the board.
Profitability Proft Banks’ net income divided by
Total Assets

Measuring the Green Banking

Our main variable of interest here is Green Banking, which is an equally weighted
index based on dummy variables. First, we identified the components of green
banking based on the literature and then we did the content analysis in which we
examined the sources of secondary data which includes the annual reports, green
banking publications, and the websites of the banks to get information regarding the
green activities of the banks. The information collected is then transformed into
quantitative data to measure the magnitude of the banks’ green activities. According
to the dummy variable technique, if a bank unveils the information related to green
banking items in the annual reports, it was assigned a score of “1” and if the related
data is not present, then it was assigned a score of “0”. Details of the components of
Green Banking Practices we have considered while constructing the index are
summarized in Table 2

49
Table 2 Components of Green Banking Index (UNEP, 2021)
Governance Environment Social
Green HRM Green Building Employee Right
Green Finance Natural resources Stakeholder Awareness
conservation
Green report Elimination of wastage Islamic CSR
Green Audit Green product and
services

Next, we present a detailed discussion on the descriptions and definitions of these

components of our Green Banking index.

Governance
i. Green HRM
GHRM spread awareness among the employees and society about the usage of
natural resources in an economical way. If the Banks are performing the following
activities, they were assigned a score “1” otherwise “0”
• Job sharing,
• Car sharing,
• Electronic filing,
• Virtual interviews,
• Teleconferencing,
• Online recruitment and training,
• Recycling,
• Energy-efficient office spaces, etc.

ii. Green Finance

Any financial process, a product, or service that is devised either to safeguard the
natural environment or to handle the impacts of the environment on finance and
investment is called green finance. If the Bank is financing the companies that are
providing and supporting environmentally friendly products and services e.g.
green tech projects, recycling projects etc. then they are assigned a score “1”
otherwise “0”.
iii. Green Report
A report on an organization’s financial status has been printed using the method of
production that preserves energy, water, and trees and mitigates waste and carbon
emission is called a green report. Soy inks are used to print eco-friendly green
reports. Soy inks are simpler to recycle paper. Even the annual reports of the banks
are called green reports as they are available online and no paper is wasted.

50
iv. Green Audit
It is a method of identification and evaluation of a business regarding its influence
on the environment. The main purpose is to scrutinize the internal and external
environmental practices, which are affecting the environmentally friendly
atmosphere. The green audit is very beneficial in determining how and where most
of the energy or resources are being utilized which can further help them to execute
changes and efficiently use the resources. If the banks are providing green audit
report then they are given a score of “1” otherwise “0”

Environment
i. Green building

A building that is designed, constructed, or operates in a way that eliminates the

adverse effects and develops a positive influence on the natural environment and
climate. Green buildings help in the conservation of natural resources. If the banks
are doing any of the things mentioned below, they are given a score of 1

• Installing solar panels

• Superior air quality
• Water efficiency
• Use of efficient light bulbs
• Noise control
• Installation of HVAC (Heating, Ventilation and Air conditioning)
• Rooftop Planting etc.

ii. Natural resource conservation

It is a procedure of efficient utilization and proficient handling and conservation of

natural habitat with all its resources. It includes:

• Use less water

• Turn of the lights
• Use renewable energy
• Choose reusable goods
• Recycling etc.
• Solar panels
• Less usage of the paper

iii. Elimination of wastage

The practice of reducing all the wastage dangerous or not at its root and when the
wastes cannot be avoided, then to use tactics that are environmentally sound to
reuse and recycle them. It includes:
51
 • To use reusable goods
• Recycling
• Curb the use of paper etc.

iv. Green products and services

The products and services benefit the environment and help in preserving natural
resources. Green products are made to reduce their carbon footprints and do not
affect the environment throughout their life and after it. Green products are made
using toxic-free elements and methods that are environmentally friendly. If the bank
is offering any of the product, they are assigned a score “1”

• Green mortgage
• Green car loans
• Online banking
• Remote deposit capture
• Green credit cards

Social
i. Employee rights
They are both the legal rights and the human rights of an employee. Several
approaches are used to protect the employee in a firm. This includes the following
attributes:

• Staff get together

• Appreciation of Achievement
• Employee Benevolent fund trust
• Medical benefit and health facility
• High-tech security systems and security guards deployed at the Bank's
premises
• Provision of a trained and assigned team to aid staff in the case of a fire or
natural calamity etc.

ii.Stakeholder Awareness
Stakeholders should have an awareness of the ongoing project and product.
Stakeholders’ perspectives come into light when they participate in the business
either directly or by choosing a representative. The awareness of the stakeholders
and their engagement in the business helps the organization to view their demands,
which further helps to generate a good trustworthy connection between the
organization and the stakeholders.

52
 iii.Islamic CSR
Islamic CSR focuses on moral principles and social responsibility by the principles
of sharia law [28, 39]. According to sharia law gharar, usury, and destruction of the
natural environment are forbidden, and they stress more on moral and ethical
behavior.

Measuring the Cost of Capital

We represented the cost of capital of the sample banks through two measures i.e.
the Cost of Equity (COE) and Cost of Debt (COD). Details of their measurement are
given below.
Cost of Debt
The cost of debt is another measure of the cost of capital that we are using in our model. We
follow (Yeh et al., 2020), (Francis et al., 2005) and (Izzo & Magnanelli, 2012) and measure
the cost of debt by the ratio “financial interest expense/interest-bearing debt outstanding”. All
the service costs of using the capital to prior the deduction for capitalized interest is included
in the interest expense. The interest-bearing debt includes loans, short-term financing and
deposits. The cost of debt is calculated by using the formula given below:
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐸𝑥𝑝𝑒𝑛𝑐𝑒
𝐶𝑂𝐷 = ____________________(3)
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐵𝑒𝑎𝑟𝑖𝑛𝑔 𝐷𝑒𝑏𝑡 𝑂𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔
Besides these main variables, we also included some control variables (mentioned
in table 1) as suggested by the previous literature to have an association with the
cost of capital. These control variables include Dividend payment (DivP), Firm size
(FirmS), Capital structure (CaptS), Board Size (BSize), Board Independence (BInd)
and Profitability (proft).

Sample Description
In this section we describe the sample characteristics with the help of graphical
analysis and descriptive statistics of the variables of this study. Below in Table 3, we
present the summary statistics of the variables.
Table 3 Descriptive Statistics
Variables Mean Std. Min Max Medium
Dev.

Cost of 4.794 1.533 2.038 8.8567 4.562

Debt

Cost of 4.794 34.613 5.632

Equity -79.530 72.743

DivP 30.515 29.680 -0.003 98.016 32.009

CaptS 91.573 4.100 73.884 98.424 92.474

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 Firm_Size 480,826,546 4.620 14,871,806 2,301,899,086 331,205,452

Profit 0.840 0.921 -4.202 2.957 0.880

BSize 8.615 1.772 0 13 8

Bind 82.884 9.732 42.857 100 85.714

The descriptive results for our sample of banks are displayed in Table 3. The average
cost of debt across our sample is 4.794% with minimum and maximum value of 2.0%
and 8.8% respectively and the average cost of equity of the banks is 4.7% with
standard deviation of 34.61 and ranging between as minimum as -79.5% and as high
as 72.7%. This represents that it is a very diverse sample having small and big banks
and therefore it is fit for analysis.
Next in Table 4 below, we present the correlation matrix that shows our results of the
Pearson Correlation Coefficients among all the variables of the study

54
Table 4 Correlation Table
Cosequit CosDeb Costofcapit Env_Inde Soc_Inde Gov_Inde GreenB DIVIDEN FSIZ BSIZ BIN
y t al x x x K D E DTA Profit E D

Cosequity 1

CosDebt -0.1209 1
Costofcap
ital 0.1696 -0.3539 1
Env_Inde
x 0.0296 -0.2472 0.2331 1
Soc_Inde
x 0.1258 -0.1639 0.038 0.1252 1
Gov_Inde
x 0.0427 -0.2845 0.2412 0.6501 0.1285 1

GreenBK 0.0628 -0.3116 0.2564 0.8877 0.3304 0.8939 1

DIVIDEN
D 0.0717 -0.3976 0.445 0.2764 0.1155 0.2519 0.2997 1

FSIZE 0.0073 -0.4706 0.4729 0.3806 -0.0071 0.3898 0.4029 0.5892 1

0.296
DTA -0.1028 -0.1004 -0.0251 0.2548 -0.1712 0.2027 0.2058 -0.0846 4 1
0.418 -
Profit 0.1702 -0.3076 0.7761 0.1157 0.0849 0.1403 0.1512 0.5687 8 0.365 1
0.080 0.018 0.188
BSIZE -0.0119 -0.0724 0.2493 0.4584 0.0086 0.3545 0.4274 0.0481 6 6 5 1
0.291 0.089 0.231
BIND 0.1496 -0.2653 0.2175 0.0774 0.1065 0.1677 0.1503 0.2066 9 7 3 0.1759 1

The correlation s among the variables of this study are summarized in Table 4 above. The Pearson correlations in the above table
show that there is no issue of any multicollinearity among the independent variables used in this study, hence meeting the basic
assumption for further data regressions.

55
Figure 1 presents a graphical representation of the average score of each of the sample
banks on our overall green banking index over the sample period while Figure 2 plots
the banks by their scores of the components of green banking.

Average Score Green Banking by Bank

Alfalah Bank Limited
Allied Bank Limited
Askari Bank Limited
Bank Al Habib Limited
Bank Islami Pakistan Limited
Faysal Bank Limited
Habib Bank Limited
Habib Metropolitan Bank Limited
JS Bank Limited
MCB Bank Limited
Meezan Bank Limited
National Bank of Pakistan
Samba Bank Limited
Silk Bank Limited
Soneri Bank Limited
Standard Chartered Bank Pakistan
Summit Bank Limited
The Bank of Khyber
The Bank of Punjab
UBL Bank Limted

0 2 4 6
Green Banking

Fig 1: The Average score of Green Banking by Banks

Mean Environmental, Governance and Social Scores by Banks

Alfalah Bank Limited

Allied Bank Limited
Askari Bank Limited
Bank Al Habib Limited
Bank Islami Pakistan Limited
Faysal Bank Limited
Habib Bank Limited
Habib Metropolitan Bank Limited
JS Bank Limited
MCB Bank Limited
Meezan Bank Limited
National Bank of Pakistan
Samba Bank Limited
Silk Bank Limited
Soneri Bank Limited
Standard Chartered Bank Pakistan
Summit Bank Limited
The Bank of Khyber
The Bank of Punjab
UBL Bank Limted

0 1 2 3

Mean of Governance Score Mean of Environmental Score

Mean of Social Score

Fig 2: The Average Score of the Components of Green Banking by Banks

56
From Figure 1 most of our sample banks are measured halfway of the scale. They have
an average green banking score of 3. Then there are banks who have a green banking
score of 4 and 6. Similarly, Figure 2 shows that Askari Bank and Habib Metropolitan
Bank are performing better in governance than all the other banks. The mean of
environmental score is high of Habib Bank Limited which means they are
contributing more towards the environment followed by Allied Bank, Askari Bank
and United Bank Limited. The graph shows that there are 12 banks out of 20 who are
more socially responsible than the remaining 8 banks with the mean of social score of
3.

RESULTS AND DISCUSSION

Green Banking Practices and the Cost of Equity Capital
First, we estimate our hypothesized relationships of the impact of green banking
practices on the cost of capital of the sample banks by taking the Cost of Equity as a
measure of the cost of capital. We start analyzing these relationships, first with the
overall green banking scores of the sample banks (results shown in Table 5), followed
by the impact of the three main components i.e. environmental, social and governance
scores (results shown in Table 6). Finally, the relationships of the subcomponents of
green banking with the cost of equity are tested (results shown in Table 7).

Table 5 shows that green banking in our sample has had no effect on the cost of equity.
This result is partially in line with the findings of Yeh et al. (2020) who also found that
the one- year lagged values of CSR scores of the sample firms were unrelated to the
cost of equity while the two-year lagged values showed an increasing impact on the
cost of equity of the sample firms. We believe that while one may expect that the firms
that are socially responsible can easily take advantage of lower equity costs (Botosan,
1997; K. C. Chen, Chen, & Wei, 2009; Hail & Leuz, 2006). We conclude that stock
market investors are indifferent to any green banking practices. This finding in our
sample may be a reflection that these banks are adopting green banking under
regulatory pressures, as advocated in the Legitimacy theory that organizations adopt
and comply with the legislations and policies that apply in their operating
environments (Nurmalia, 2021). Further, the stock market, being possibly aware of
this, therefore does not price this aspect. Since the green banking regulations were
mostly imposed by the government and regulatory authorities rather voluntarily
adopted. This might, in turn, be increasing their expenses and may even increase their
risk of doing business too.

57
Table 5 Cost of Equity and Green Banking
VARIABLES Cost of Equity Capital
Gbanking 0.628
(1.607)
CaptS 0.253
(0.830)
Proft 8.864**
(4.231)
DivP -0.0214
(0.124)
FirmS -7.851*
(4.211)
Bsize -1.350
(1.670)
Bind 0.670*
(0.342)
Constant 133.0
(90.11)
Observations 175
R-squared 0.079
Number of Banks 20
Standard errors in parentheses *** p<0.01, ** p<0.05, * p<0.1
This table represents the impact of the overall Green Banking score of sample banks
on their cost of equity. The cost of equity is one of the proxies of the dependent variable
cost of capital. The cost of capital is estimated by taking the natural log of stock
prices/previous stock prices. Green banking is calculated using a dummy variable.
Capital structure is the debt to asset ratio and profitability is the return on assets.
Dividend income is the ratio of dividends paid by net income. Firm size is the natural
log of deposits Board size is the total number of members on the board of directors and
board independence is the total number of non-executive members on the directors’
board

58
Table 6 Cost of Equity and the ESG Components of Green Banking

VARIABLES Coat of Equity Capital

GovTotal 2.044
(4.235)
EnvTotal -0.0178
(2.811)
SocialTotal -1.249
(7.915)
CaptS 0.272
(0.859)
Proft 9.178**
(4.335)
DivP -0.0237
(0.125)
FirmS -8.072*
(4.292)
Bsize -1.428
(1.750)
Bind 0.661*
(0.350)
Constant 142.3
(96.65)

Observations 175
R-squared 0.084
Number of Banks 20

Standard errors in parentheses *** p<0.01, ** p<0.05, * p<0.1

This table represents the impact of the Environmental, Social and Governance (i.e.,
ESG) components of green banking on the cost of equity. These components are
measured using dummy variable whereas cost of equity is measured as the realized
excess returns.

59
Table 7 Cost of Equity and Green Banking Sub-Components
Variables Cost of Equity Capital
GHR -3.716
(7.514)
GFINANCE -6.519
(8.397)
GAUDIT 19.07
(14.66)
GBUILDING -2.328
(9.429)
NaturalResourceCon -4.498
(8.654)
EliminationofWastage 3.301
(8.435)
GreenProductsandServices 9.272
(12.07)
IslamicCSR -2.191
(8.050)
CaptS 0.0182
(0.925)
Proft 8.241*
(4.499)
DivP -0.0664
(0.134)
FirmS -4.777
(5.063)
BSize -1.519
(1.823)
Bind 0.792**
(0.366)
Constant 75.19
(113.3)
Observations 175
R-squared 0.087
Number of Banks 20
Standard errors in parentheses *** p<0.01, ** p<0.05, * p<0.1
This table shows the results of the impact of sub-components of Green Banking on the
cost of equity. The sub-components of governance include green HR, green finance,
green audit and green report. The sub-component of environment consists of green
building, natural resource conservation, elimination of wastage and green product
60
and services and lastly the green banking component social comprises of stake holders’
awareness, employee rights and Islamic CSR. The results in both table 6 and 7 again
show no relationship between the cost of equity and components of green banking
practices. Our results are consistent with the findings of Nelling & Webb, (2009), who
also did not find any relation between social responsibility and financial performance.
Green Banking Practices and the Cost of Debt Capital
In this section we estimate our hypothesized relationships through the impact of
green banking practices on the cost of capital of the sample banks, thereby taking the
Cost of Debt Capital, as a measure of the cost of capital. As with the cost of equity, we
again estimate these relationships first with the overall green banking scores of the
banks, then with its ESG components and then finally with the sub-components of the
green banking index. Results are shown in Table 8, 9, and 10 respectively.

The results in Table 8 show a significantly negative relationship of green banking with
the cost of debt. The more a bank is involved in green banking practices the less will
be the cost of debt. This finding is in line with the finding of Cooper and Uzun (2015)
a negative relationship between social responsibility and cost of debt. In the context
of the theory of finance, it will be inefficient to invest in a firm who is socially
irresponsible (Spicer, 1978). We think that this can be because the corporate might
want to invest in companies who are socially responsible and are working their way
towards green banking. Overall this finding is in conformity with the Socially
Responsible Investment (SRI) theory and with (Qirem et al., 2023; Yunidwi &
Napitupulu, 2024) who argue that green banking enhances the goodwill and
authenticity of the banks which benefits them by achieving financial goals (Qirem et
al., 2023; Yunidwi & Napitupulu, 2024)

61
 Table 8 Cost of Debt and Green Banking
VARIABLES Cost of Debt

GBanking -0.173***
(0.0570)
CaptS -0.00692
(0.0320)
Proft -0.231*
(0.120)
DivP -0.0106**
(0.00459)
FirmS -0.0448
(0.168)
BSize 0.0565
(0.0716)
Bind -0.0493***
(0.0106)
Constant 11.73***
(3.998)

Observations 194
R-squared 0.249
Number of Banks 20
Standard errors in parentheses *** p<0.01, ** p<0.05, * p<0.1
This table shows the impact of overall score of banks on our Green Banking Index on
their cost of debt. Cost of debt is the proxy of cost of capital measured using financial
interest expense by interest bearing debt outstanding.

62
Table 9 Cost of Debt and the ESG Components of Green Banking
VARIABLES Cost of Debt
GovTotal 0.0986
(0.182)
EnvTotal -0.215*
(0.117)
SocialTotal -1.219***
(0.319)
CaptS -0.00992
(0.0328)
Proft -0.177
(0.119)
DivP -0.0102**
(0.00451)
FirmS -0.0800
(0.172)
BSIZE 0.00168
(0.0738)
Bind -0.0442***
(0.0106)
Constant 15.51***
(4.218)
Observations 194
R-squared 0.322
Number of Banks 20
Standard errors in parentheses *** p<0.01, ** p<0.05, * p<0
This table reveals the effect of the Environmental, Governance and Social components
of Green Banking by sample banks on their cost of debt. Cost of debt is the proxy of
the cost of capital measured using financial interest expense by interest bearing debt
outstanding.
The results in Table 9 show that there is a negative and significant relationship
between the environmental and social components of green banking with the sample
banks’ cost of debt. This finding is in line with the finding of Bauer and Hann (2010)
who found, in a sample of 582 U.S public corporations, that environmental concerns
are related to increased cost of debt financing and decreased credit ratings and the
environmental practices which are proactive are linked with the low cost of debt.
Moreover, these results are also broadly in support of the Stakeholders and
Legitimacy Theories.

63
 Table 10 Cost of Debt and the Sub Components of Green Banking
VARIABLES Cost of Debt
GHR 0.258
(0.325)
GFINANCE 0.0174
(0.309)
GAUDIT -0.0747
(0.619)
GBUILDING -0.0177
(0.397)
NaturalResourceCon -0.788**
(0.312)
EliminationofWastage 0.345
(0.337)
GreenProductsandServices -0.778
(0.477)
IslamicCSR -1.149***
(0.315)
L_DTA -0.00327
(0.0336)
L_Profit -0.161
(0.120)
L_DIVIDEND -0.0112**
(0.00457)
L_lnofdeposits -0.0852
(0.177)
BSIZE 0.0187
(0.0730)
BIND -0.0436***
(0.0107)
Constant 12.56***
(4.319)
Observations 194
R-squared 0.104
Number of Bank 20
Standard errors in parentheses. *** p<0.01, ** p<0.05, * p<0.1
This table represents the impact of the sub-components of the green banking on the
cost of Debt of our sample banks. These components are measured using dummy
variables. Cost of debt is the proxy of the cost of capital measured using financial
interest expense by interest bearing debt outstanding.
64
Table 10 shows our random effects of the relationship between the cost of debt on the
sub-components of the green banking scores for the sample banks. The results show
that natural resource conservation and Islamic CSR are significant but has a negative
relationship with the cost of debt. Past studies also shown the matching results,
explaining that the nations who have high religiosity are prone to use less debt
financing (Cai & Shi, 2019; H. Chen, Huang, Lobo, & Wang, 2016). The entrepreneurs
who are religious pays low cost of debt (Li, Xu, Gill, Haider, & Wang, 2019). The
results are also consistent with the following studies (Gati, Harymawan, & Nasih,
2022; Jiang, John, Li, & Qian, 2018; Shad, Lai, Shamim, & McShane, 2020).

In addition to these findings, we further found that amongst control variables

Profitability, Firm Size, Dividend Payments and Board Independence are important
determinants of the cost of equity and cost of debt in our sample of Pakistani listed
banks. These results are also in conformity with the findings of the previous literature
on the cost of capital.

CONCLUSION
In this study we analyzed the relationship between the green banking and cost of
capital of the listed banks in Pakistan over a sample period of 10 years from 2010-to
2019. The data was collected by using the bank’s annual reports and websites. We
recognized the green banking components based on the literature then further
dummy variable was used for the data collection of green banking. Cost of capital
was measured by using cost of equity and cost of debt. Our results showed that the
overall green banking total, its components and sub-components, does not affect the
cost of equity at all in our sample, so we think that equity holders are just considering
it as a formality due to regulations. In case of cost of debt, we found that green
banking practices are effectively reducing the cost of debt of sample firms, and we
think this can be because the corporate might want to invest in companies who are
socially responsible and are working their way towards green banking. We further
found out that Board independence, profitability, firm size and dividend payments
are other important determinants of cost of debt and equity capital of banks in
Pakistan.

This is a developing issue which is associated with international efforts to integrate

sustainability into financial systems and business practices. As most of the existing
research on green banking emphasized on advanced economies, this study focuses on
Pakistan, a developing county, drawing attention to its challenges and opportunities
while implementing the green banking practices with an adolescent financial system
and regulatory framework. This research explored how green banking can affect the
stakeholder’s perception. The banks that adopted green banking practices are viewed
as much safer, while improving their reputation.
Though, the banks of Pakistan have started realizing the significance of green policies
in their day-to-day activities. Still, there are only a few banks who are busy with

65
internal and external environment management and are providing green finance. The
banks should be motivated by the distinct government along with non-government
organizations to transit towards environment-friendly enterprise rather than profit-
seeking. This will help in increasing awareness regarding sustainable business
practices. The customers are still not aware of green banking so, in this regard, banks
should arrange some branch-level events which might help the customers to change
their perspective about green banking and are willing to adopt online banking. This
is because the customers still want to have a printed document like banks statement.

Some progress has been made in evaluating the relationship between cost of capital
and green banking of Pakistan listed banks. However, a more integrated approach is
needed to find this relationship between different types of banks in Pakistan e.g.
Islamic vs commercial banks or government vs. private banks. It is evident which
types of banks are performing more green banking policies in their operations. The
cost of equity is not related to green banking in our sample. In future, researchers can
dig out the reasons why there is no relation between them. The researchers can also
investigate the channel and reasons why the cost of debt is responding to green
banking and not cost of equity.

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