Do Banks Overreact to Disaster Risk?

Abstract

We examine how banks respond to natural disasters when borrowers are adjacent to the disaster area. We find robust evidence that banks charge significantly higher spreads to firms located in these areas following a disaster than they charge to other firms. The observed effect is unlikely to be driven by regional spillovers, limited credit supply, rational learning, or lender rent extraction. Bank lenders also respond to faraway severe disasters if the borrowing firm is vulnerable to a similar type of disaster risk. Overall, our findings indicate that banks are subject to salience bias when assessing their clients' natural disaster risk.

Keywords: Disaster Risk; salience bias

JEL Classification: G21; G40; G41