Circular economy transition and banking-sector financial performance in South Asia

The transition toward circular economy has been gained increasing attention as a means to foster sustainable development and boost economic resilience. However, empirical evidence on the association of circular economy transition with banking-sector financial performance remains limited, especially in the case of developing economies. This study aims to analyses the association between circular economy transition and financial performance of aggregate banking sector in four South Asian countries, namely Bangladesh, India, Nepal and Pakistan from 2000 to 2021. Banking-sector Return on Assets (ROA) and Return on Equity (ROE) are used to indicate the financial performance of the banking sector, whereas circular economy transitions captured using two alternative proxies: adjusted net savings including particulate emission damage (CE1) as the baseline measure and adjusted net savings excluding particulate emission damage (CE2) as an alternative measure. The empirical analysis is based on the panel econometric approach including the tests of cross-sectional dependence, cross-sectional slope heterogeneity, panel unit roots and cointegration tests, followed by the estimations of Feasible Generalized Least Squares (FGLS), Fully Modified Ordinary Least Squares (FMOLS), Dynamic Ordinary Least Squares (DOLS) and Instrumental Variables Two-Stage Least Squares (IV-2SLS). The results reveal that in the baseline FGLS estimates, there is a positive and statistically significant association between Circular economy transition and aggregate banking-sector ROA, but the positive association between Circular economy transition and ROE is statistically insignificant. The estimates from the FMOLS and DMOLS also show positive and significant long-run association between Circular economy transition and ROA and ROE respectively. There is significant variation in the strength and consistency of such links from country to country as shown by the country-specific estimates: Bangladesh, India, Nepal, and Pakistan. The IV-2SLS analysis supplements the main results in the event that there is a potential endogeneity issue, but is not sufficient to definitively establish a causal effect. Lastly, a sensitivity analysis with another indicator (CED2, a proxy for Circular economy transition) yields broadly similar patterns, reinforcing the sensitivity of the principal results to other indicator. Overall, the study results indicate that aggregate banking-sector financial performance is positively linked to Circular economy transition, and that this link becomes stronger in the long run, but are dependent on the national context.