Banking on Carbon: Corporate Lending and Cap-and-Trade Policy

We estimate the effect of carbon pricing policy on bank credit to greenhouse-gas-emitting firms. Our analyses exploit the geographic restrictions inherent in California’s cap-and-trade bill and a discontinuity in the embedded free permit threshold of the federal Waxman-Markey cap-and-trade bill. Affected high emission firms face shorter loan maturities, lower access to permanent forms of bank financing, higher interest rates, and higher participation of shadow banks in their lending syndicates. These effects are concentrated among private firms, while credit terms of public firms are largely unaffected. Overall, we show that banks respond quickly to realizations of transition risk.