Non-technical summary

This research investigates how euro area banks factor pollution-induced biodiversity risks into their lending decisions, using data from 832 banks and 5,000 major polluters. The study aims to integrate dual negative externalities—climate change and biodiversity loss—into a loan pricing framework. The results demonstrate that banks are increasingly pricing these risks by adjusting loan-to-value (LTV) ratios and interest rates. Banks adjust lending conditions in line with European Union (EU) pollution and biodiversity protection legislation, particularly for companies with large pollution footprints near protected areas or those contributing to Environmental Quality Standards (EQS) failures of downstream surface waters. The findings offer actionable guidance for financial supervisors on leveraging existing regulatory frameworks to address the climate-biodiversity-pollution nexus.

Introduction

Despite the alarming decline in biodiversity and the potential for significant economic losses, public attention remains disproportionately focused on climate change. Biodiversity loss undermines ecosystem health and resilience and can cause financial instability. To mitigate these challenges, European policymakers have strengthened legislation to reduce pollution and preserve areas of high biodiversity value. Simultaneously, financial supervisors are recognising the importance of mitigating environmental externalities beyond climate to ensure long-term financial resilience. This study examines how euro area banks factor the potential environmental impacts of chemical pollutant emissions into their lending decisions to mitigate exposure to risks affecting their borrowers’ operations.

A primer on the EU’s zero pollution legislation and hypothesis building

The roots of current EU legislation to safeguard ecosystems are based on the United Nations’ Convention on Biological Diversity (CBD) and the Kunming-Montreal Global Biodiversity Framework (GBF). A key target is reducing pollution risks to levels that are not harmful to biodiversity by cutting pollution from excess nutrients and hazardous chemicals by at least half. The research postulates three hypotheses: first, that banks adjust lending to pollution-induced biodiversity risks; second, that credit conditions are more stringent for polluting firms operating near biodiversity-sensitive areas (such as Natura 2000 sites); and third, that banks amend lending conditions for polluters contributing to EQS failures in downstream water monitoring stations.

Data and methodology

The study integrates multiple data sources, including the European Environmental Agency’s E-PRTR data on 91 pollutants and the European Commission’s Environmental Footprint (EF) method. Loan-level information is sourced from the European Central Bank’s AnaCredit registry, which covers loans above €25,000 and represents approximately 80% of the euro area corporate loan landscape. The researchers developed measures for biodiversity impacts (proxied by freshwater ecotoxicity) and climate impacts (calculated from plant greenhouse gas emissions). A panel regression approach was employed to investigate banks’ pricing of freshwater ecotoxicity while controlling for firm-specific characteristics such as profitability, leverage, and total assets.

The pricing of emission-related biodiversity risks in loans: Results with discussion

The results show that banks mitigate risks from freshwater ecotoxicity emitters by providing fewer loans per unit of collateral. A one-unit increase in log-freshwater ecotoxicity leads to a decrease in LTV ratios of 16.9 basis points (bps) for total loans and 27.9 bps for new loans. The findings also reveal that firms operating near Natura 2000 protected areas face significantly more stringent credit conditions, with LTV reductions most pronounced within 1km (-32.9 bps) and 2km (-25.2 bps) distances. For large polluters within 1km of these areas, this translates to a 21 percentage point reduction in the LTV ratio relative to non-polluters.

Furthermore, the study indicates that banks drastically reduce LTV ratios for firms contributing to ‘good chemical status’ failures as defined by the EQS. In the total set of loans, banks result in up to 41 percentage points less collateral for firms contributing to more than three failures at the nearest downstream monitoring site. While LTV adjustments are the primary risk mitigation strategy, banks also charge interest rate premiums for smaller polluters, debt refinancing purposes, and loans with longer maturities. Signatories to the Equator Principles were found to be more proactive in pricing these risks, particularly for newly originated loans.

Conclusion

The findings suggest that biodiversity protection legislation is starting to influence financial decision-making in the banking system. By reducing LTV ratios for large polluters, banks reduce their exposure to biodiversity risks in their corporate loan portfolios. Lending patterns appear aligned with concepts proposed in sustainable finance and water protection legislation. The results underscore the importance of supervisory bodies and policymakers extending their focus to consider emission-related biodiversity risks in their regulatory frameworks. While establishing robust causal relationships is an essential next step, this framework supports the European Union’s zero pollution ambition and provides a model for global biodiversity protection via the financial sector.