Carbon emissions and bank risk around the world

We examine how carbon emissions affect bank risk using a sample of global banks. We find that carbon emissions are associated with higher bank risk measured by the net loan charge off ratio and risk weighted asset ratio. The baseline results still hold with addressing endogeneity issues and other robustness checks. Furthermore, we document that banks making more (less) brown (green) loans and the less development and adoption of climate adaptation technology are two underlying economic mechanisms for the positive relationship between carbon emissions and bank risk. Cross sectional tests show that the impact of carbon emissions on bank credit risk is more pronounced in countries with greater climate policy uncertainty and more regulatory scrutiny. On the other hand, central bank green policies related to capital requirement, climate risk disclosure, and green taxonomy/subsidy mitigate the effect of carbon emissions on bank credit risk. Our empirical results have important implications for banks, regulators, and central banks.