Climate vulnerable firms in the US pay more for loans, says study

The paper is among a growing body of research investigating the pricing of climate risks

US companies in locations that are more exposed to climate-related risks are being charged significantly higher interest rates on bank loans, a study from the University of Texas has found.

According to an analysis of loan pricing data, researchers concluded that companies in areas which are exposed to drought pay 1.6% higher interest for each standard deviation increase in a widely-used US national index, which measures drought in 48 states. The findings are supported by three additional measures of climate risks encompassing damages caused by rainfall, windstorms and flooding.

Researchers found that the impact of climate risks on the cost of borrowing was particularly acute among long-term loans, where a standard deviation increase in climate risk was associated with a 2.23% rise in the interest rates of long-term loans.

Additionally, the study concluded that as climate risks increased, lenders were more likely to reduce the size of loans, insist on issuing secured loans and increase the number of covenants. The number of participants of loan syndicates were also shown to decrease as borrowers’ climate risks increased.

Authors of the study concluded that while their analysis had revealed “an adverse impact of climate risk on loan spreads”, the evidence suggested a “slow and gradual increase in lenders’ attention to this risk and that the financial market has yet to fully understand and price all dimensions of climate risk”.

“Our results suggest that lenders are concerned about the physical risk of climate change and that they require a premium for bearing this risk. The debate about climate change and its causes have no impact on this premium. Requiring this premium is the consequence of the increased physical risk and uncertainty about repaying loans to lenders caused by climate change,” they added.

The latest study adds to a growing body of research investigating the pricing of climate risks. This includes recent papers on the higher costs of borrowing for firms excluded by environmental screens, the impact of rising sea levels on property prices and the consequences of climate risk on regulatory/litigation risk.