Climate risks and climate policies are expected to have a major impact on the financial system. In recent years, financial authorities have required banks to embed climate risks into their risk management frameworks, including in their Internal Capital Adequacy Assessment Process, the so-called ICAAP. While some policy makers are exploring the explicit use of prudential measures to direct funds away from high-carbon activities and into green sectors, the main objective of prudential capital requirements is to enhance the soundness and stability of financial institutions. Whether newly implemented climate-related prudential measures affect bank lending and firm activity is an open empirical question with important policy implications. For example, negative effects on bank lending would imply that there are costs associated with bank capital that curb the ability of banks to support firms in climate-exposed sectors. It is possible that such outcomes, even if unintended, might be desirable to the extent that they promote the divesting in some high-carbon activities. However, constraining the supply of credit to firms with significant exposure to climate change risk might be detrimental as it limits their ability to finance the transition to a less carbon intensive economy.
In a recent paper (Miguel et al., 2022), we evaluate a 2017 policy introduced in Brazil requiring systemically important banks –with assets greater than 10% of Brazil’s GDP– to incorporate environmental risks in their capital adequacy assessments. We use bank lending data and a taxonomy of environmentally exposed sectors to examine the incidence of the policy on bank credit, firms’ economic activity, and on greenhouse gas emissions (GHG). We find that the introduction of the new 2017 ICAAP led to a lending reallocation by large banks away from exposed sectors. The change in credit to exposed sectors by large banks was also in the form of shorter loan maturity, as the ratio of short-term loans to such sectors increased substantially after the reform (see Figure 1). In contrast, banks that were exempt from the ICAAP exercise increased their total credit volume and loan maturity to firms in exposed sectors after the regulation. In fact, we find that at the aggregate level, the lending expansion by smaller banks to firms in exposed sectors makes up for the contraction of credit by larger banks.
