The Rising Tide Lifts Some Interest Rates: Climate Change, Natural Disasters and Loan Pricing

74 Pages Posted: 15 Oct 2020 Last revised: 21 Jul 2023

See all articles by Ricardo Correa

Ricardo Correa

Board of Governors of the Federal Reserve System

Ai He

University of South Carolina - Darla Moore School of Business

Christoph Herpfer

University of Virginia, Darden School

Ugur Lel

University of Georgia - Department of Banking and Finance; European Corporate Governance Institute (ECGI)

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Date Written: March 31, 2020

Abstract

Banks price physical climate change risks after observing natural disasters linked to climate change. We isolate this updating process by identifying loans to borrowers at risk of, but not directly affected by, such disasters. Loan spreads for these borrowers spike in both primary and secondary markets following these disasters, while no such updating occurs for non-climate-related disasters. Banks adjust internal probabilities of default, consistent with a higher perceived credit risk. However, the observed increase in spreads is primarily explained by salience bias, as it is short-lived and amplified by media attention. This salience impacts financial decisions at bank-dependent firms.

Keywords: Banks, climate change, loan pricing, natural disasters

JEL Classification: G21, Q51, Q54

Suggested Citation

Correa, Ricardo and He, Ai and Herpfer, Christoph and Lel, Ugur, The Rising Tide Lifts Some Interest Rates: Climate Change, Natural Disasters and Loan Pricing (March 31, 2020). European Corporate Governance Institute – Finance Working Paper No. 889/2023, Available at SSRN: https://ssrn.com/abstract=3710451 or http://dx.doi.org/10.2139/ssrn.3710451

Ricardo Correa

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Ai He

University of South Carolina - Darla Moore School of Business ( email )

1014 Greene Street
Columbia, SC 29208
United States

HOME PAGE: http://www.aihefinance.com/

Christoph Herpfer (Contact Author)

University of Virginia, Darden School ( email )

P.O. Box 6550
Charlottesville, VA 22906-6550
United States

Ugur Lel

University of Georgia - Department of Banking and Finance ( email )

Terry College of Business
Athens, GA 30602-6253
United States

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

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