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Do Banks Price Environmental Risk? Evidence from a Quasi Natural Experiment in the People’s Republic of China

Publication | July 2019
Do Banks Price Environmental Risk? Evidence from a Quasi Natural Experiment in the People’s Republic of China

Policy makers and stakeholders much assess the risks that environmental degradation and climate change pose for the stability of the financial system.

This paper maps the risk arising from the transition to a low-emission economy and studies its transmission channels within the financial system. The environmental dynamic stochastic general equilibrium (E-DSGE) model shows that tightening environmental regulations deteriorates firms' balance sheets as it internalizes the pollution costs, which consequentially accelerates the risks that the financial system faces. This empirical study, which employs the Clean Air Action that the Chinese government launched in 2013 as a quasi-experiment, supports the theoretical implications. The analysis of a unique dataset containing 1.3 million loans shows that the default rates of high-polluting firms rose by around 50% along their environmental policy exposure. At the same time, the loan spread charged to such firms increased by 5.5% thereafter.

WORKING PAPER NO: 974