We investigate whether banks practice environmental, social, and governance (ESG) washing in their lending decisions and how the market reacts to it. That is, do banks with worse ESG performance intentionally lend to firms with better ESG performance to improve their ESG reputations? Banks with worse ESG performance offer
significantly lower loan spreads, longer loan maturities, fewer general covenants, and fewer collaterals to firms with better ESG performance. More importantly, the stock market generally reacts favorably to banks that make these kinds of deals that could explain why banks engage in ESG washing. We also find that the effects of ESG washing are significantly stronger for borrowers from high polluting industries and in the post-Kyoto Protocol period. These results support the idea that the banks with worse ESG performance divert the market's attention away from their ESG washing of their lending that thus, improves their ESG reputations.
