Environmental Risks and Loan Contract Terms

Abstract: This paper investigates whether and how firm-level environmental risks are reflected in banks’ credit policies, in absence of intense regulatory scrutiny. I find that following an adverse en- vironmental incident, banks start to take into account weak environmental performance as a fundamental risk to firms, by requiring higher loan interest rates and more restrictive covenants on firms with environmental concerns. However, this shift in lending practices is driven by banks with green expertise, that is, an information advantage accumulated through prior relationships with environmentally friendly firms. Other banks that do not possess such green expertise tend to issue loans with shorter maturities and more collateral to mitigate environmental risks. I further illustrate that banks’ green awareness get transmitted to the real economy, leading to improvements in firm-level emission reduction and green innovation.

Presentations: AFA (poster); EBA Policy Research Workshop on Technological Innovation, Climate Finance and Banking Supervision; Days-Ahead Workshop on the Future of Financial Intermediation; Bayes Business School.

A Taxonomy of Sustainable Finance Taxonomies

BIS Papers No. 118

with Torsten Ehlers and Frank Packer

Abstract: Sustainable finance taxonomies can play an important role in scaling up sustainable finance and, in turn, in supporting the achievement of high-level goals such as the Paris Accord and the UN sustainable development goals. This paper develops a framework to classify and compare existing taxonomies. Several weaknesses emerge from this classification and comparison, including the lack of usage of relevant and measurable sustainability performance indicators, a lack of granularity and lack of verification of achieved sustainability benefits. On this basis, the paper proposes key principles for the design of effective taxonomies. The principles are then employed to develop a simple framework for transition taxonomies. The key policy messages of the analysis are: (i) Endeavor that taxonomies correspond to specific sustainability objectives; (ii) Encourage the development of transition taxonomies and focus alignment with the objectives of the Paris Agreement; (iii) Monitor and supervise the evolution of certification and verification processes; and (iv) Shift to mandatory impact reporting for green bonds.

Featured in: SUERF; G20 Sustainable Finance Working Group.