Physical climate risk and the pricing of bank loans

This paper analyses how physical climate risk affects the pricing of loans. Using a global dataset of almost 86,000 syndicated bank loans, we find that a higher climate vulnerability of a firm’s host country leads to higher costs of borrowing. The effects of physical climate risk on loan pricing are particularly large if loans have long maturities and if borrowing firms are in financial distress. In addition to loan pricing, banks also adjust other loan terms, such as loan size, collateral requirements, or fees, to manage their exposure to their borrowers’ physical climate risk. As climate risk may also directly affect loan pricing, e.g., via general updates of credit risk models due to observed changes in climate risk, we extend the analysis to firm-level credit risk ratings. The results show that physical climate risk negatively affects long-term credit risk ratings, while it does not play a role in short-term credit risk, and hence support the proposed channel that physical climate risk affects loan pricing via its effect on firms’ default probabilities.