Abstract
The role of banks in supporting the low-carbon transition has proved controversial as they seem to price climate transition risk but also maintain investments in polluting industries. To investigate the reasons and implications of this situation, this paper provides first a theoretical benchmark for the carbon premium, based on a formalization of the concept of climate sentiments, the policy-dependent present value of firms' capital, and the Merton model. I find that the current empirical evidence for carbon premia matches a reasonable calibration of investment dynamics in productive capital, with a limited space for higher premia even when banks strongly expect future climate-mitigation policies. Second, I consider discrepancies in climate sentiments between lenders and borrowers, to determine when banks could push reticent borrowers to green their operations, or prevent them from doing so. I find that variations in the cost of debt due to the carbon premium are generally a second-order factor, and not enough of a decarbonization incentive alone. Macro-prudential measures that complement climate risk pricing and policies that limit the volume of high-carbon loans would then be necessary to decarbonize the economy further through the financial system.
Local Organizer: Emanuele Campiglio