Essays on financial institutions' response to climate and tariff risks

Abstract

This dissertation consists of three essays in the areas of financial economics and climate finance, examining the response of financial institutions to environmental risks and tariff changes. The first essay investigates if banks pay attention to the investment preference of ESG-committed mutual funds and issue loans at preferable terms to firms with higher ESG ownership. I use firm-level share fraction of US PRI (Principles for Responsible Investment) mutual funds as a proxy for ESG ownership. I find that even though PRI ownership does not improve firm ESG profile in the following year, banks on average significantly increase the amount and reduce the interest rate of new loans issued to firms with higher PRI ownership. I also show that PRI ownership is not likely to be a proxy for firm credit risk or stock return and banks' response is largely driven by banks that exhibit more environmental awareness. Overall, the results show that banks factor in borrowers' ESG ownership structure when evaluating new loans. In the second essay, my co-authors and I study the existence and effect of local bias of US mutual funds on firms affected by hurricane landfalls. We find that local funds increase normalized shares of disaster-zone firms in the disaster quarter relative to non-local funds. With-in fund style analysis also suggests the existence of local bias. Compared to non-local funds, local funds increase the portfolio weight of firms headquartered in disaster-zone counties. The investor loyalty of local funds following natural disasters does have real economic impacts on disaster-zone firms. Preliminary analysis shows disaster-zone firms with higher proportion of shares held by local funds prior to disasters tend to have higher excess return and make more short-term investment in the disaster quarter, thus potentially having better financial recovery from disasters. The third essay studies the effects of industry-level tariff reductions on bank new lending and banks' existing borrowers one year after the tariff reductions. High-exposure banks decrease new lending to borrowers in the affected industries relative to borrowers in the unaffected industries. Using two measures of prior bank-firm relationship, I find that banks decrease new lending only to non-relationship borrowers and actually support relationship borrowers in the affectedindustries. Moreover, there is a spillover effect from firms in the affected industries to unaffected industries through the bank-firm network. Existing borrowers in the unaffected industries tend to increase cash holding and decrease R&D expenditure as a result of enhanced bank monitoring. Overall, these findings suggest that banks can act as intermediaries for shock transmission from affected to unaffected borrowers, resulting in real impacts on unaffected borrowers.