A Question of Trust? Banks’ Climate Sentiments, Lending Behavior and the Low-Carbon Transition

Abstract

We study how banks’ climate sentiments affect their lending decisions and economic decarbonization. Banks can form expectations about firms’ performance in the low-carbon transition either in a backward-looking(firms’ GHG emissions) or forward-looking way (firms’ technology alignment). We analyse how such expectations lead to adjustments in investment decisions, macroeconomic and financial indicators, conditioned to the climate scenarios of the Network for Greening the Financial System. We calibrate the EIRIN macro-financial model to Austria and we find that banks’ climate sentiments reinforce the impact of orderly carbon tax introduction on decarbonization (- 20% GHG emissions in comparison to current policies)and on co-benefits (avoided GDP losses). However, banks’ climate sentiments can also counteract the impact of the policy, depending on how expectations affect the revision of lending conditions for high and low-carbon investments. In particular, expectations leading to credit constraints on low-carbon investments hinder the low-carbon transition.

Keywords: Banks' climate sentiments, Carbon pricing, banking, Credit risk, climate finance, Investment, Low-carbon transition, Co-benefits.