Banks charge ‘dirty’ firms more. Is climate risk pricing taking off?

We did it, folks.  Years of educating the financial industry on climate risks and enhancing climate-related supervision looks like it’s starting to pay off.  Banks are pricing climate risk in their lending policies.

At least that’s the headline from a new working paper out of the European Central Bank (ECB). By combining detailed bank credit info with data on their borrowers’ carbon emissions, the researchers found that lenders charge the most climate-polluting companies more to borrow funds than their ‘greener’ peers.  In addition, companies that do not promise to reduce future emissions are consistently charged more than those that do pledge to cut back.

This suggests that polluters are being penalized for being riskier than cleaner companies, all else being equal.  Moreover, it suggests that forward-looking data – a hot button issue for Tony and myself – is being used to inform lending decisions.  Banks don’t just care what companies are emitting today, they worry about what they’ll emit in the future.

Is this Mission Accomplished?  The drumbeat for banks to get serious on climate risks from activists, regulators, and civil society has grown steadily in recent years.  A key ask has been that lenders recognize how ‘dirty’ companies are likely to struggle in a world of tightening climate policies and adjust accordingly.  Charging differential interest rates on loans is one way to manifest this understanding. Indeed, the ECB paper appears to reinforce earlier data-based studies, including from the Bank for International Settlements, that banks apply a “carbon premium” to ‘dirty’ borrowers.

Now I’m not one to rain on anyone’s parade – but Unpacking Climate Risk is not a place for me to cherry-pick the findings on climate risk that make me happy.  A deeper dive into the ECB paper makes me think we should hold off popping the champagne corks.