The Rising Tide Lifts Some Interest Rates: Climate Change, Natural Disasters, and Loan Pricing

Abstract

Banks adjust loan spreads after observing natural disasters linked to climate change. We isolate this updating process by identifying loans to borrowers at risk of, but not directly affected by, such disasters. Loan spreads for these borrowers spike in both primary and secondary markets, while no such updating occurs for non–climate-related disasters. Evidence suggests a heightened perceived credit risk, which nonetheless cannot fully explain the increase in rates. Taken altogether, increased spreads are explained primarily by salience bias, as they are short-lived and amplified by media attention. This salience impacts financial decisions at bank-dependent firms.