Financing the Supply Chain Sustainability: The Role of the Bank's Responsibility Level

ABSTRACT Financial instruments have become an emerging solution to establish sustainable supply chains recently. This paper investigates the effectiveness of a new tool called the sustainability‐linked loan (SLL), which contains a sustainability target, a regular interest rate as well as a discounted rate. If borrowers meet the target at the maturity of the loan, they can enjoy an interest discount, otherwise the regular rate is charged. We consider a retailer that procures a single product from a supplier, under which the supplier is capital‐constrained and can exert costly effort to raise the product sustainability performance. We study two SLL models: the first one is called the supplier profit‐responsibility (SPR) model, where a bank offers the SLL to the supplier, and the bank's objective is to maximize its own profit plus the supplier's effort. Compared with a general loan that contains only an interest rate, the SPR model always induces a higher effort level while weakening the supplier's profit. The second model is called supplier total responsibility (STR) model, under which the bank is totally responsible only to maximize the supplier's effort. We find that the bank's responsibility level (i.e., the weight of effort in the bank's objective function under the SPR model) significantly affects the comparison between the two SLL models. In particular, with a higher responsibility level, while the SPR model induces greater supplier effort, which benefits the retailer, the supplier and the bank obtain lower profits compared to those in the STR model. Furthermore, if the bank's responsibility level is intermediate, the SPR model produces a multi‐lose situation: the sustainability level, the profit of the bank and the supply chain are all worse off compared to the STR model. Our results show that when providing the SLL, the bank's preference regarding supply chain sustainability plays a vital role.