The effect of climate policies on firm financing and investment through the banking channel

This paper assesses to what extent markets with sophisticated investors and large firms price transition risks due to climate policies affecting the corporate cost of debt. Unlike previous studies, we focus the analysis on the impact of climate policy on the allocation of capital. We isolate the effect of mitigation policies on syndicated loans' spreads by exploiting yearly variation in countries' climate policy stringency interacted with firm-level measures of environmental performance. The analysis yields three main results. First, stringent climate policies significantly lower the cost of debt of firms with good environmental performance (in terms of emission intensity or patenting activity in mitigation technologies). Second, ESG scores and their environmental pillar – which correlate poorly with firms’ actual environmental performance – are not sufficiently informative to assess and price domestic transition risks. Third, more stringent mitigation policies can encourage investment in green firms by reducing their cost of debt.