Carbon intensive lending by banks results in higher credit risk: Study
New Delhi: Banks with higher exposure to carbon-intensive sectors face rising credit risk over time, resulting in greater monitoring and recovery costs, according to a study by IIM Lucknow researchers.
The study explores how lending to high-carbon industries influences banks’ long-term financial health and operational efficiency. Published in the Journal of International Financial Markets, Institutions and Money, it highlights the growing link between sustainability and financial performance, stressing the need to align banking strategies with the global transition to a low-carbon economy.
While banks are not direct carbon emitters, they indirectly contribute by financing sectors such as fossil fuels and heavy manufacturing. These exposures create transition risks that are often not captured in traditional risk assessments, particularly as climate policies evolve.
Based on an analysis of 158 banks across 26 countries, the researchers found that institutions with greater exposure to carbon-intensive sectors tend to become less efficient over time. This is largely due to increasing regulatory scrutiny and policy shifts, which make such borrowers riskier.
As a result, banks face higher credit risk, leading to increased costs for monitoring loans and recovering dues when assets turn non-performing.
The study also introduces a new metric to assess carbon-sector exposure by combining loan concentration with carbon emissions data, enabling a more precise evaluation of risks in lending portfolios.
Researchers emphasised the importance of maintaining strong capital buffers, noting that well-capitalised banks are better positioned to absorb risks from carbon-heavy lending and limit efficiency losses.
The report recommends that banks reassess their lending portfolios with a long-term perspective and gradually shift toward greener assets. It also offers guidance for regulators to design effective climate-risk and capital policies, underscoring that transitioning to sustainable finance can benefit both the environment and the banking sector’s performance.
