Climate policy risk and the pricing of bank loans

Banks are increasingly factoring climate risk into the loans they offer to fossil fuel companies, according to this new research paper by Initiative in Sustainable Finance theme lead Steven Ongena et al. As a result, companies holding on to large reserves of coal, oil, and gas could face significantly higher borrowing costs in the future, especially in regions with stricter climate policies.

Published in Financial Markets, Institutions and Instruments journal, the study analyzes data from loan deals and company reports to understand how banks consider fossil fuel reserves when setting loan rates. The researchers found that: ​

• Higher fossil fuel reserves lead to higher loan rates.
  The study reveals a direct correlation between higher fossil fuel reserves and higher loan rates. This effect is even more pronounced for companies operating in countries with stricter climate policies or located near coastlines, where the impacts of climate change are often felt more acutely. ​
• The Paris Agreement marked a turning point.
  The effect became significantly stronger after 2015, coinciding with the Paris Agreement, a global commitment to combat climate change, and the implementation of stricter environmental regulations in some regions. ​
• Especially "green banks" are wary.
  The study found that banks participating in the United Nations Environment Programme Finance Initiative, known as "green banks," charge even higher rates to fossil fuel companies. This suggests that climate risk is a growing concern across the entire financial sector.

These findings highlight the growing financial pressure on fossil fuel companies as the world transitions to a low-carbon economy. With banks increasingly wary of the risks associated with these companies, they may face significant challenges securing loans, potentially impacting their ability to invest and operate.

This research carries significant implications for both the financial sector and the energy industry: ​

• For investors, it underscores the importance of considering climate risk when making investment decisions.
• For policymakers, it highlights the potential role of financial regulations in accelerating the transition to a low-carbon economy. ​

Being stranded with fossil fuel reserves? Climate policy risk and the pricing of bank loans
Manthos D. Delis, Kathrin de Greiff, Maria Iosifidi, and Steven Ongena
Financial Markets, Institutions & Instruments (forthcoming)

Photo by Chris LeBoutillier on Unsplash