Climate risk and loan pricing: the moderating role of trilemma policy choices

Muhammad Umar (), Farzan Yahya () and Amad Rashid ()
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Muhammad Umar: Wuhan College
Farzan Yahya: Nanchang Institute of Technology
Amad Rashid: Forman Christian College University

Economic Change and Restructuring, 2025, vol. 58, issue 4, No 15, 40 pages

Abstract: Abstract Climate risk amplifies loan pricing by heightening perceived lending risks, compelling financial institutions to adjust interest rates in response to elevated default probabilities associated with climate events. Using a global sample of 119 countries from 2000 to 2020, we document a robust positive association between climate risk and loan prices across multiple proxies, with results holding after addressing endogeneity concerns. Our analysis of the moderating role of trilemma policy choices reveals that greater monetary policy independence mitigates this positive association, while exchange rate stability amplifies it. Notably, monetary union policy configurations emerge as the optimal choice for minimizing the adverse associations between climate risk and loan pricing. Our heterogeneity analysis reveals that the climate risk-loan pricing relationship is amplified in economies with expansionary monetary conditions, low-income level, high bank profitability, high capital adequacy, and elevated interest rates. The association intensified following the global financial crisis, with particular prominence in the Middle East and African regions, suggesting regional and temporal variations in climate risk transmission to financial markets. Policymakers should align monetary policy configurations and financial integration to build lending markets that can withstand climate risks.

Keywords: Loan pricing; Climate risk; Monetary policy independence; Trilemma; Financial institutions (search for similar items in EconPapers)
Date: 2025
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DOI: 10.1007/s10644-025-09904-0

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