Low emission companies deemed higher credit risk by banking sector data models - Oxford analysis
A new working paper by academics at the Oxford Smith School and INET finds that banks’ risk models assign lower credit risk to higher-emitting companies, raising questions about whether transition risks are fully reflected in these assessments as the world switches to clean energy. As a result, the banks assess these companies as being less risky than those with low emissions, which could lead to higher borrowing costs for clean energy companies.
The findings may have implications for the clean energy transition, which is vital for the world to meet its climate targets.
“Our paper uses euro-area credit register data combined with firm-level carbon emissions to examine whether risk models that banks use for regulatory purposes assign different risk assessments to companies with different emissions profiles and the downstream impacts on capital requirements and borrowing costs,” explains author Fulvia Marotta, Honorary Research Associate at the Smith School of Enterprise and the Environment. The data captured by the paper covers over 7000 borrowers and over 100 lenders across the Euro Area between 2019 and 2024.
Previous research has concluded that high emission companies pay higher interest rates than green companies after accounting for their estimated probability of defaulting on their debts. However, this working paper looks at an earlier stage in the process – how banks calculate the probability of default in the first place. “When we go to the step before in the lending process, and we look at how these risk assessments are estimated by banks internal models we find something quite striking. These risk estimates are a key input into capital requirements and often influence interest rates, yet we see they are significantly higher for low emitting companies,” says Marotta.
However, the authors stress that responsibility for resolving this issue lies not just with the banking sector, but also with governments and policymakers. “If governments were more consistent and firmer in their climate policies, this would send a clearer signal about transition risks, which would encourage banks to account for them more clearly,” explains Marotta.
“Our findings carry direct implications for prudential regulation,” says lead author Matteo Gasparini, Associate Fellow at INET, University of Oxford. “If banks’ internal models do not price transition risk, Pillar I capital requirements calibrated on these models may understate banks’ true risk exposure to high-carbon borrowers. And if low-carbon borrowers face funding costs that do not reflect their lower transition risk, this could raise their cost of capital and slow investment in decarbonisation, hampering the aims of climate policy elsewhere in the economy.”
