Carbon Footprint of Bank Loans: Opportunities and Risk Implications in the Banking Industry

ABSTRACT This study examines whether the carbon footprint of bank loan portfolios influences bank stability, profitability and cost efficiency and whether regulatory quality moderates these relationships. Using a balanced panel of 33 countries from 2005 to 2018, the analysis combines banking‐sector indicators from the World Bank Global Financial Development Database with financed‐emissions measures derived from the IMF climate data repository, alongside relevant macroeconomic and industry controls. To ensure robust inference, the study employs Driscoll–Kraay standard errors, feasible generalised least squares and Lewbel IV‐2SLS estimation to address cross‐sectional dependence, heteroskedasticity, serial correlation and endogeneity. The results show that carbon‐intensive lending is associated with higher measured financial stability and lower cost‐to‐income ratios, indicating short‐run operational benefits linked to established, cash‐flow‐generating sectors where climate risks may not yet be fully internalised. However, the relationship with profitability remains weak and statistically insignificant, suggesting that efficiency gains do not translate into sustained earnings once latent climate exposures, provisioning needs and capital pressures are considered. Regulatory quality does not significantly moderate these relationships, implying that broad institutional strength alone is insufficient to alter the performance effects of carbon‐intensive lending. Additional analysis reveals heterogeneity across country groups, with stronger stability and efficiency effects in advanced economies and weaker outcomes in emerging markets. These findings highlight the need for standardised financed‐emissions measurement, enhanced disclosure and forward‐looking climate stress testing.