Understanding the Effect of Climate Risk on Banking Business—A Panel Data Analysis of Indian Firms

The enormous phenomenon of climate change, which is affecting many organisations of different sectors today, has a special impact on the financial sector in terms of credit risk. Awareness and action on environmental, social and governance (ESG) goals and climate change impacts have been rapidly increasing worldwide. In this article, we present a firm-level panel data analysis to link ESG ratings and CO 2 emissions with the default risk and solvency position of selected companies. We perform various univariate and multivariate analyses on selected top Bombay Stock Exchange (BSE) top 200 companies that have disclosures in Carbon Disclosure Project (CDP) reports over 5 years (2017–2021). We find strong empirical evidence that a firm’s risk of default is linked to its environmental performance along with the level of carbon emission. Our findings will enable banks to establish a linkage between credit risk and climate change risk. This will assist banks as well as policymakers to adjust borrower-level ratings and align their lending and investments with net zero emissions. JEL Codes: G32, G33, Q2, Q5