Policy Brief

PB 1/2024: Climate Risks and the Cost of Debt: Why Climate Policy Matters

  • Climate policy is key to achieving the required CO2 emission reductions for the
    transition towards a sustainable low-carbon economy.
  • Climate policy causes direct and indirect compliance costs and negatively
    affects the financial performance of carbon-intensive firms or firms in the
    fossil fuel sector, which translates into a higher default probability.
  • Recent empirical evidence demonstrates that increases in climate policy
    ambition increase the credit risks and, therefore, the costs of debt of carbon-intensive firms.
  • There are “winners” and “losers” of climate policy: tighter climate regulations
    increase the credit risks and costs of debt of high-emission firms, while those
    of low-emission firms decrease.
  • Climate policies provide rules and incentives for firms to reduce carbon
    emissions, while also affecting financing costs and playing a key role in
    redirecting capital flow towards low-carbon activities.
  • Too lenient climate policy provides insufficient incentives for emission
    reductions and can also reduce the capital flows to firms aligned with the
  • Climate policy should be complemented by sustainable finance instruments,
    such as climate-related reporting, which enable creditors to better asses
    climate-related risks, and transition plans, which can help high-emission
    firms raise capital to finance their transition.
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