Essays on ESG Risk and Bank Lending

  • Binru Zhao

Student thesis: Doctoral ThesisPhD


This thesis is based on four independent essays which are interlinked. Bank loan is one of the most important financing sources for public firms. How to measure and manage borrowers' risks is an eternal topic in the bank lending. Borrowers' leverage risk, which is closely associated with credit risk and default risk. Previous literature has widely recognised that it could affect firms' loan pricing since lenders seek to receive compensation from the potential deterioration of borrowers' solvency. I use an exogenous shock (The Clarification of Interagency Guidance in 2014) to investigate the leverage risk pricing in syndicated loans by comparing different attitudes towards leverage risk between banks and nonbank lenders. I find that leveraged loan spreads have declined rapidly for nonbank facilities relative to bank facilities since the introduction of the 2014 Interagency Clarification. The decline in leveraged loan spreads is significant for highly leveraged borrowers, especially when term loans are involved. I further demonstrate that a higher degree of information asymmetry, driven by an increase in covenant-lite loan issuance and weaker investor protection, is strongly associated with a narrower leverage risk. In addition, adverse selection and moral hazard associated with the high level of collateralised loan obligations issuance significantly contribute to the decline in the leverage risk premium for nonbank leveraged loans. My results suggest the necessity of enhancing the current regulation of leveraged lending, especially in the shadow banking sector. In addition to leverage risk as a type of traditional credit risk. In recent years, Environmental, Social and Governance (ESG) risk as an emerging risk has been widely discussed. Different from leverage risk in the syndicated loan, the interplay between ESG risk and the debt market is not clear. How does ESG risk shape the relationship between borrowers and the debt market and change the debt financing environment? I find that companies with higher ESG risk borrow less from banks than from markets, potentially to avoid bank monitoring and scrutiny. The Social and Governance components, in particular, matter. Overall, my study presents solid empirical evidence on the interplay between borrower ESG reputation risk and debt financing. Considering that being “responsible” has achieved consensus amongst many commercial banks, I explore the role of ESG rating in shaping lending relationships in the syndicated loan market and the potential mechanism behind this relationship. Firms with high ESG scores are more likely to borrow from banks with high ESG and that this lending relationship can improve a firm's future ESG performance. High ESG firms are charged lower loan spreads and have fewer financial covenants imposed in their loan contracts, especially when lenders are high ESG banks. This chapter further extends the discussion on ESG risk and debt market and reveals the interplay between ESG risk and financing choice. Furthermore, I try to investigate funding liquidity risk, this is another type of risk faced by banks in the syndicated loan market. prior literature show that bank funding constraint is closely related to the loan contract designs and bank stock performance. However, prior literature lacks empirical evidence to support the relation between bank funding liquidity and bank stock liquidity. My results provide evidence that funding constraints significantly impact bank stock liquidity. The impact is more pronounced during crisis periods. Deteriorating bank stock liquidity is, in turn, priced into excess stock returns. In addition, I find that during liquidity crises, monetary expansion (Heightened monetary policy uncertainty) can break (strengthen) the relationship. This chapter provides an essential policy indication that the monetary authorities must realize the trade-off between addressing inflation and triggering a dangerous liquidity crisis.
Overall, this thesis investigates three different risks (leverage risk, ESG risk and liquidity risk) faced by banks in banking. Focusing on those three risks can help us enhance our understanding of the banking sector's new development and contribute to our current macro or micro-prudential regulations.
Date of Award29 Mar 2023
Original languageEnglish
Awarding Institution
  • University of Bath
SupervisorRu Xie (Supervisor) & David Newton (Supervisor)

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