Climate Transition Challenges: Exploring Credit Portfolio Misalignment in European Banks

ABSTRACT This paper examines the underlying factors contributing to the misalignment of banks' credit portfolios with European environmental objectives. Drawing on panel data on green lending from 2015 to 2023, the empirical analysis reveals that such misalignment is primarily influenced by the country and sector in which the financed firms operate. The main findings indicate a positive relationship between green lending and the environmental performance of the country where the firm is based. Moreover, the significant presence of carbon‐intensive sectors within national economies shapes banks' credit allocation decisions, reflecting broader structural characteristics rather than bank‐specific strategies. Policymakers are therefore encouraged to support the alignment of bank lending with climate goals through public policies and enhanced regulations that promote firms' business model innovation. In addition, the implementation of appropriate macroprudential tools may help address the systemic dimension of climate‐related financial risk.