Climate-related Disclosures, Market Discipline, and Banks' Risk-Taking

In this paper, I shed light on the impact of climate-related disclosures on banks' investment and risk-taking decisions. To that end, I develop a model in which banks raise deposits from socially responsible depositors that are partially insured. Brown banks finance projects that generate negative externalities and may be exposed to financial climate risk, whereas green banks invest in projects that do not generate externalities but may still be financially risky. Consistent with the financial-materiality perspective, climate-related disclosures provide information about the climate risk of brown banks' projects. In the absence of competition among banks, climate-related disclosures provide market discipline, decrease the riskiness of brown banks, and increase social welfare. In contrast, when banks compete in the deposit market, climate-related disclosures may increase or decrease the risk of the banks' projects. While climate-related disclosures may deter brown banks from investing in risky projects, they may increase the leverage of green banks and may therefore provide incentives to green banks to invest in riskier projects. Hence, climate-related disclosures may lead to an increase in the size of green projects being financed, but also to an increase in the riskiness of green banks, and to a decrease in social welfare. Overall, my results highlight the ambiguous effects of climate-related disclosures on banks' investment decisions.