Climate Transition Risks and Bank Liquidity Creation: Adapting to Regulatory Shocks

Francisco González, Md Rajib Kamal, Steven Ongena and Shams Pathan
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Francisco González: Universidad de Oviedo
Md Rajib Kamal: NTNU Business School, The Norwegian University of Science and Technology
Shams Pathan: University of Newcastle - Newcastle University Business School

No 25-75, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

Abstract: We examine how climate transition risks affect bank liquidity creation using the 2004 U.S. NOx Budget Trading Program (NBP)—a cap and-trade regulation affecting 11 states—as a quasi-natural experiment. Banks in NBP-affected states curtailed liquidity creation, primarily through balance sheet adjustments: reduced lending and risky asset holdings, and increased off-balance sheet exposures. Beyond this mechanism, banks adopted strategic responses to earnings pressure, including slower net interest income growth, greater noninterest income, and expanded derivative use. The effect is stronger for large, riskprone, profitable, and diversified banks, as well those in competitive markets and Democratic-leaning states. Governance matters: banks with higher common ownership are more resilient, while both shortand long-term investor horizons are associated with reduced liquidity creation—especially under shortterm ownership. Results are robust to matching, placebo tests, spillover adjustments, and event-study designs. Overall, climate regulation reshapes bank intermediation through portfolio rebalancing and strategic adaptation, with critical implications for financial stability and climate policy.

Keywords: Climate transition risk; Bank liquidity creation; Nitrogen Oxides (NOx) Budget Trading Program (NBP); Climate regulation; Ownership structure; Bank competition (search for similar items in EconPapers)
JEL-codes: G21 G28 G32 G38 L51 Q58 (search for similar items in EconPapers)
Pages: 73 pages
Date: 2025-09
New Economics Papers: this item is included in nep-ene, nep-env and nep-reg
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