BIS published a paper that examines whether banks price carbon risk in syndicated loans by combining syndicated loan data with carbon intensity data (CO2 emissions relative to revenue) of borrowers across a wide range of industries. The paper finds that carbon risks in the syndicated loan market are priced consistently both across and within industry sectors—after the Paris Agreement. The results suggest that banks have started to internalize possible risks from the transition to a low-carbon economy—but only for the risks captured by the narrowly defined scope carbon emissions. However, the overall carbon footprint of firms has not been priced. Only carbon emissions directly caused by the firm are priced and not the overall carbon footprint, including indirect emissions. Neither do banks that signal they are green nor do de facto green banks appear to charge a higher carbon premium.
The paper notes that firms with higher carbon intensity are at risk to suffer penalties if stricter climate policies, such as carbon taxes, are introduced. Hence, banks should be charging higher rates for firms with a higher carbon intensity. The results of the study point toward clear normative policy implications. Regulators and supervisors of financial institutions should design incentives to ensure regulated participants fully internalize the environmental impact of their activities, in particular on higher-level carbon emissions. One way of doing this is to implement incentives and penalties to key off ratings based on higher-level carbon emissions. While regulators and supervisors of financial institutions are already taking measures to raise awareness of climate risks among banks, they should redouble their efforts to ensure that those institutions are prepared for and are internalizing the potential for the higher levels of carbon taxes implied by the Paris emission reduction goals. An issue that has received relatively little attention in policy discussions is the decisive scope of emissions. Transition risks can affect firms not only through their direct emissions but also through reliance on carbon-intensive inputs. Ensuring greater disclosure and availability of such measures through, for example, the application of environmental standards based on broader scopes, would be highly desirable.
Central banks, both as providers of services to the banking system and through their implementation of monetary policy decisions, can also contribute to a pricing of carbon risk that is commensurate with the corresponding risks. As a start, central banks could send a strong signal by taking into account such risks in their monetary operations, such as credit provision, collateral policies, or asset purchases. For example, central banks could adjust the eligibility of collateral that define the range of securities that can be used for credit operations, to reflect the climate risk profile of the issuers of said collateral. Similarly, the haircuts at which such collateral is accepted could be calibrated to reflect the carbon risk of the issuer. While climate change mitigation through carbon emission reduction is a key global environmental goal, there are others. Efforts to ensure that the pricing of outcomes related to water security, biodiversity, or climate adaptation are in line with the internalization of policy objectives will also be an important item for the green policy agenda going forward.
Related Link: Working Paper
Keywords: International, Banking, Climate Change Risk, Syndicated Loans, Credit Risk, Paris Agreement, Transition Risk, Carbon Pricing, BIS
Dr. Denton provides industry leadership in the quantification of sustainability issues, climate risk, trade credit and emerging lending risks. His deep foundations in market and credit risk provide critical perspectives on how climate/sustainability risks can be measured, communicated and used to drive commercial opportunities, policy, strategy, and compliance. He supports corporate clients and financial institutions in leveraging Moody’s tools and capabilities to improve decision-making and compliance capabilities, with particular focus on the energy, agriculture and physical commodities industries.
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