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Environmental Risks: Should Banks Be Liable?

Listed author(s):
  • Karine Gobert
  • Michel Poitevin

This paper studies the impact of banks' liability for environmental damages caused by their borrowers. Laws or court decisions that declare banks liable for environmental damages have two objectives: (1) finding someone to pay for the damages and (2) exerting a pressure on a firm's stakeholders to incite it to invest in environmental risk prevention. We study the effect that such legal decisions can have on financing relationships and especially on the incentives to reduce environmental risk in an environment where banks cannot commit to refinance the firm in all circumstances. Following an environmental accident, liable banks more readily agree to refinance the firm. We then show that bank liability effectively makes refinancing more attractive to banks, therefore improving the firm's risk-sharing possibilities. Consequently, the firm's incentives to invest in environmental risk reduction are weakened compared to the (bank) no-liability case. We also show that when banks are liable, the firm invests at the full-commitment optimal level of risk reduction investment. If there are some externalities such that some damages cannot be accounted for, the socially efficient level of investment is greater than the privately optimal one. In that case, making banks non liable can be socially desirable. On étudie ici l'effet de la responsabilité des banques pour les dommages environnementaux causés par leurs clients. Les tribunaux qui rendent les banques responsables de la réparation des dommages poursuivent le double objectif de trouver un payeur et de faire pression sur les partenaires des firmes qui peuvent inciter ces dernières à la réduction des risques. On étudie l'impact que de tels jugements peuvent avoir sur les relations de financement et sur les incitations à la prévention dans un environnement où les banques ne peuvent s'engager à toujours refinancer la firme. ¸ la suite d'un accident environnemental, les banques légalement responsables sont plus enclines à refinancer la firme en cause. On montre alors que la responsabilité bancaire facilite le refinancement, améliorant ainsi le partage de risque obtenu par la firme.0501s, par là-même, elle diminue les incitations des firmes à la prévention. On montre également que lorsqu'il y a responsabilité bancaire, le montant investi en technologie de prévention correspond à l'optimum privé. Si le niveau d'investissement socialement efficace est supérieur au niveau optimal privé, l'absence de responsabilité bancaire, qui pousse les firmes à surinvestir en capacité de prévention, peut être socialement désirable.

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Paper provided by CIRANO in its series CIRANO Working Papers with number 98s-39.

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Length: 29 pages
Date of creation: 01 Nov 1998
Handle: RePEc:cir:cirwor:98s-39
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  1. Jonathan Thomas & Tim Worrall, 1988. "Self-Enforcing Wage Contracts," Review of Economic Studies, Oxford University Press, vol. 55(4), pages 541-554.
  2. Marcel Boyer & Jean-Jacques Laffont, 1995. "Environmental Protection, Producer Insolvency and Lender Liability," CIRANO Working Papers 95s-50, CIRANO.
  3. T. Randolph Beard, 1990. "Bankruptcy and Care Choice," RAND Journal of Economics, The RAND Corporation, vol. 21(4), pages 626-634, Winter.
  4. Segerson Kathleen, 1993. "Liability Transfers: An Economic Assessment of Buyer and Lender Liability," Journal of Environmental Economics and Management, Elsevier, vol. 25(1), pages 46-63, July.
  5. Segerson, Kathleen & Tietenberg, Tom, 1992. "The structure of penalties in environmental enforcement: An economic analysis," Journal of Environmental Economics and Management, Elsevier, vol. 23(2), pages 179-200, September.
  6. Pitchford, Rohan, 1995. "How Liable Should a Lender Be? The Case of Judgment-Proof Firms and Environmental Risk," American Economic Review, American Economic Association, vol. 85(5), pages 1171-1186, December.
  7. Boyer, Marcel & Laffont, Jean-Jacques, 1997. "Environmental risks and bank liability," European Economic Review, Elsevier, vol. 41(8), pages 1427-1459, August.
  8. Weitzman Martin L., 1994. "On the Environmental Discount Rate," Journal of Environmental Economics and Management, Elsevier, vol. 26(2), pages 200-209, March.
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