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Can sustainability-linked lending reconcile environmental and financial motives?

Author

Listed:
  • George, Ammu
  • Huang, Jingong
  • Nie, He
  • Xie, Taojun

Abstract

Differentiated lending terms for clean and dirty capital have become a popular tool among commercial banks as they promote themselves as advocates of environmental sustainability. Using a two-sector New Keynesian Dynamic Stochastic General Equilibrium (DSGE) model where emissions are a by-product of dirty capital, we incorporate an interest spread responding elastically to carbon emissions: Banks offer lower lending rates to clean capital investment agencies when emission growth exceeds a target level. We find that while banks’ offering emission-elastic lending rate (EELR) is consistent with the regulator’s welfare objective, there is a tendency for banks to overreact to carbon emissions, resulting in increased loan volume, and thus, uncertainties in the financial sector. Although EELR faces more financial sector uncertainty, it outperforms Green Capital Requirements (GCR) in lowering the economic risk associated with the green transition.

Suggested Citation

  • George, Ammu & Huang, Jingong & Nie, He & Xie, Taojun, 2025. "Can sustainability-linked lending reconcile environmental and financial motives?," International Review of Financial Analysis, Elsevier, vol. 104(PB).
    • Handle: RePEc:eee:finana:v:104:y:2025:i:pb:s1057521925004041
    DOI: 10.1016/j.irfa.2025.104317
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    Keywords

    Climate policy; Monetary policy; New keynesian model; Bank lending; Macroprudential policy; Green finance;
    All these keywords.

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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