For years, climate experts have insisted that markets will naturally push companies to take climate change more seriously as risks become more apparent. Fresh research indicates that borrowers are now starting to face a financial penalty for ignoring the dangers ahead.
This month, a paper published by the European Central Bank found that banks with the greatest so-called transition risks now “face significantly higher borrowing costs” in funding markets. That followed a December paper by analysts at the Central Bank of Ireland, which showed that companies facing physical climate risks are in a similar predicament, and will need to provide more collateral.
The studies examined the two main ways companies should, theoretically, feel the pain of global warming. Transition risk — the notion that companies slow to cut high-carbon activities will be punished by regulators and markets — has often seemed difficult to quantify, in part because many governments keep delaying efforts to move toward net zero emissions. But physical risk — which covers the real-world impact that extreme weather has on assets such as buildings — is getting harder to ignore as climate disasters mount.
“These papers illustrate well how the economics of the transition is working on a micro-, day-to-day level in the financial system,” said Ulf Erlandsson, chief executive of the Anthropocene Fixed Income Institute.
Margherita Giuzio, a senior economist at the ECB, along with Bige Kahraman and Jasper Knyphausen of the Oxford Saïd Business School, explored how banks’ exposure to carbon-intensive borrowers affects funding costs in the European repo market. (The repo market allows banks to manage short-term cash by selling and then buying back high-quality securities such as government bonds, often overnight.)
The researchers combined data on European banks’ 2019-2022 repo borrowings with information on their financed emissions (the carbon footprint of firms’ capital allocations). They found that banks with higher financed emissions consistently pay more to borrow on the repo market. Specifically, an increase of one standard deviation in financed emissions translates into repo rates that are 7% to 12% higher on average, they said.
Continue reading “Costs and Uncertainty Climb as Markets Price in Climate Risk”
