Sustainability Governance Mechanisms and Financed Emission Mitigation: The Mediating Role of Greenwashing Risk in Islamic Banks

Abstract

This study investigates the impact of sustainability governance mechanisms on emission mitigation financed by Islamic banks and tests whether the greenwashing risk accounts for the relationship. The study is based on stakeholder theory, legitimacy theory, institutional theory, and the Islamic ethical perspective of Maqasid al-Shariah. The study employs panel data of Islamic banks in Pakistan for 45 observations covering bank-years from Refinitiv DataStream and banks' sustainability disclosures. Sustainability governance is done by three channels: sustainability committees, sustainability-linked compensation, and sustainability reporting. The indicators of the financed emission mitigation are a binary indicator that records if the bank has environmental and climate-related criteria in its financing decisions, and indicators of the greenwashing risk are captured through a disclosure-performance gap index. The results show that these three factors, sustainability committees, sustainability-linked compensation, and sustainability reporting, have positive and statistically significant impacts on financing emission mitigation. These study findings also help mitigate the risk of greenwashing, indicating that governance enhances the trustworthiness of sustainable practices. This research adds to the sustainable finance and Islamic banking literature by demonstrating governance structures that minimize the disconnect between ESG disclosure and environmental performance.