Read Full Paper

Corporate stakeholders have long assessed companies based on indicators of financial performance. Recently, however, “softer” indicators have been added to these assessments, under the rubric of corporate social responsibility (CSR). Today, CSR significantly influences depositors’ assessments of banks’ trustworthiness, according to HKUST’s Mingyi Hung and colleagues. Their study, which examines social responsibility ratings across a large sample of U.S. banks, shows that depositors react strongly when banks receive a low social responsibility rating. Their findings have important implications for bank stability.

“While stakeholders’ response to CSR is a timely and relevant topic,” note the researchers, “prior research is silent on this issue in the banking sector.” This is an unfortunate omission, as banks are important players in the economy and their social performance is the focus of considerable public attention. To fill this gap, the authors examine how depositors respond to bank social performance by exploiting the regulatory releases of bank performance ratings for community development.

Specifically, they investigate deposit flows for 250 banks that have been downgraded on commonly accepted measures of social responsibility (that is, rated as “needs to improve” by regulatory agencies). They match each of these banks to a benchmark bank — a bank that has not received a ratings downgrade and that has similar characteristics (e.g., size and geographic location). The 250 matched pairs are observed on a quarterly basis between 1996 and 2017. The resulting dataset is broader than those designed in prior research, the authors say; it “covers all US banks and is staggered over a long time span.” This enhances the generalizability of their results.

Analysis of this rich, granular dataset reveals that deposits tend to be withdrawn at a higher rate after a bank is downgraded in terms of social responsibility, particularly in regions where communities place high value on altruism and trustworthiness. This finding, the researchers say, is “consistent with the expectation that depositors with high propensity to trust react more strongly to poor bank social performance.”

After a bank’s social responsibility score weakens, and after funds are withdrawn, where does the money go? Hung and colleagues observe that funding is redirected to geographically adjacent banks, especially those with good social responsibility rankings. Although depositors face potential frictions when moving money in this way (such as the considerable effort and cost involved in finding a new bank), this is insufficient to deter depositors from moving their money out of banks with which they are dissatisfied from a social responsibility perspective.

“In addition,” say the authors, “insured and uninsured deposits respond similarly to the negative events, suggesting that depositors’ concerns over bank social performance is different from concerns about bank financial performance.”

Prior studies have documented how depositors respond to traditional fundamental measures of bank performance. However, as the authors note, the literature to date “does not model or empirically test depositors’ responses to banks’ social performance.” Their study not only contributes to the literature but also provides important implications for ensuring the stability of banks—key components of a well-functioning economy.