Market Bonds allocate funds more efficiently towards climate transition than bank loans
Initiative in Sustainable Finance: What role plays market versus bank debt for climate transition? Study by Steven Ongena and Winta Beyene
A study by Prof. Steven Ongena and Winta Beyene (PhD graduate from the Department of Finance), along with co-authors (Manthos D. Delis, Kathrin de Greiff) examines how fossil fuel firms finance their operations amid increasing climate regulation. The authors provide insights on the role and the interplay of two primary sources of debt — public bonds and private bank loans — for climate transition goals and reveal a systemic shift from bond markets to (syndicated) bank loans.
While bond markets allocate credit in line with climate transition goals, bank loans are not pricing climate transition risks to the same extent. This increases systemic risks to the financial market and undermines functioning market mechanisms to implement political, societal and climate goals.
Bonds vs. Bank Loans
The authors show how fossil fuel firms with greater exposure to climate policy increasingly substitute bonds with syndicated loans. Especially firms facing stranded asset risks (see box) prioritize bank loans, as bond markets impose higher premiums on these risks. The findings suggest banks underprice transition risks, enabling fossil fuel firms to bypass market discipline. “Large banks’ willingness to underprice stranded asset risks creates a dangerous feedback loop, where fossil fuel dependence deepens even as climate policies intensify,” Steven Ongena warns.
Chart: Credit allocation towards fossil fuel
Role of (Large) Banks
Larger banks dominate fossil fuel lending, offering cheaper terms and larger loans, even to companies holding stranded assets risks, creating a "too-big-to-strand" scenario. The findings highlight misaligned incentives in debt markets, with implications for financial market stability and climate policy effectiveness. While the authors are cautious about deriving strong causal claims from these correlations, their findings provide initial evidence that large banks with implicit government backing may take greater risks by lending to fossil fuel firms.
Currently, syndicated fossil fuel debt totals around $7 trillion, posing significant systemic risks if regulatory measures do not address the underpricing of climate risks by banks.
Implications for Climate Transition
“Our findings underscore the urgent need to recalibrate financial incentives, ensuring both bond and bank markets align with climate objectives. Addressing the "too-big-to-strand" dilemma is critical to preventing stranded assets from destabilizing the global economy”. -Steven Ongena
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Stranded Assets To achieve the Paris Agreement long-term temperature target, a large share of global fossil fuel reserves cannot be harnessed and burned. As soon as countries implement relevant regulations, these reserves will become stranded assets. New Measure for firms’ climate transition risks The authors introduce a novel measure for firms’ climate policy exposure. It is based on the product of the quantity of fossil fuels a firm holds within a specific country and that country’s potential willingness to implement stricter climate policies within a given year. As policies tighten, the amount of potentially stranded reserves increases, impacting profit and credit-related outcomes. |
More Information:
Beyene, Winta; Delis, Manthos D; De Greiff, Kathrin; Ongena, Steven (2021). Too big to strand? Bond versus bank financing in the transition to a low carbon economy. London: VoxEU, CEPR Policy Portal. https://www.zora.uzh.ch/id/eprint/210648/
Study: ECON committee
Financial institutions' exposures to fossil fuel assets. An assessment of financial stability concerns in the short term and in the long run, and possible solutions. By Winta Beyene, Manthos Delis, Steven Ongena
https://www.europarl.europa.eu/RegData/etudes/STUD/2022/699532/IPOL_STU(2022)699532_EN.pdf
Initiative in Sustainable Finance News