Climate Change Is Increasing Corporate Loan Costs, but Is It Being Priced Correctly?

Public discourse and corporate action have shifted away from the need to address climate change in recent years, but its effects continue to have real financial consequences for businesses.

To understand those costs, University of Virginia Darden School of Business Professor Christoph Herpfer and coauthors Ricardo Correa, Ai He and Ugur Lel, conducted new research. Their paper, “The Rising Tide Lifts Some Interest Rates: Climate Change, Natural Disasters, and Loan Pricing,” was published in The Journal of Finance.

What the researchers found is that banks are pricing physical climate risk into corporate loans, but—to their surprise—the climate risk premiums are often overinflated, reactionary, temporary, and subject to biases based on lenders’ locations and experiences.

A Novel Way to Isolate the Cost of Physical Climate Change Risk

Extreme weather has always existed, and not all events are attributable to climate change. Thus, not all financial and economic impacts of extreme weather can be attributed to climate change.

Yet, Herpfer says it is a common poor practice in the dialogue around climate change to point to the increasing economic costs of extreme weather as evidence of climate change impact. Herpfer says the increase in weather-related damages is primarily caused by humans moving themselves and economic activity into harm's way in already disaster-prone areas like Florida or California—echoing an argument made by Nobel Prize-winning economist William Nordhaus—and to a lesser extent by worsening disasters.

So, how to isolate costs associated with actual physical climate change risk—and not just risk associated with operating in areas prone to extreme weather?

The researchers found there was a scientific consensus that Atlantic hurricanes have become more intense due to climate change. They hypothesized that historical corporate loan data would show a measurable price on the risk of physical climate change in corporate loans for businesses with operations in areas most at risk of being struck by a hurricane.

But loan rates can also be impacted by changes in credit demand related to post-disaster recovery. To strip out such confounding factors, they focused on changes in loan spreads offered to borrowers with operations in hurricane-prone areas that were not directly affected by a specific storm—“at-risk but unaffected borrowers.” For example, if a hurricane struck Miami, the researchers examined the change in loan spreads from that point in time forward for businesses operating in at-risk, unaffected areas like New Orleans and Houston. Those changes, they reasoned, effectively isolate banks’ revised beliefs on the risk of physical climate change.

Imagined Risks, Real Costs to Business

The experiment was conclusive. Businesses operating in unaffected but at-risk areas saw their corporate loan rates spike by 19 basis points in the months after a major hurricane struck elsewhere. That’s the equivalent of a one-notch downgrade in credit rating—for example, from A to BBB—for every business in an at-risk, unaffected area.

As rates rose in the primary loan market, the price of loans to at-risk firms also fell in the secondary market, which Herpfer says helped confirm the finding that the cost of climate risk was real. They also found the exact same pricing patterns for wildfires and floods, two other major climate change linked disasters, while there was no effect for earthquakes or winter weather, disasters that are not predicted to worsen with the climate.

To put the impact in terms of real money: The median at-risk firm experienced an almost $1 million increase in debt costs when it took on new debt after a hurricane hit elsewhere in the United States, a nearly 7% increase to its pre-storm per-loan servicing costs.

But once the price of physical climate change risk was established, Herpfer says, the surprises started to emerge.

For starters, the researchers found that the 19-basis-point increase was temporary. After a few months, loan rates to at-risk firms returned to pre-storm levels in both primary and secondary loan markets. Because climate change is long lasting, any correctly assessed risk attributable to physical climate change should have remained priced in.

As such, Herpfer and his coauthors concluded that banks were actually overreacting to individual hurricanes due to the salience of media coverage and other information discussing the storms in relations to climate change. When coverage of the storm abated—and salience dwindled—rates dropped.

In short, bankers panicked.

But not all bankers.

Parsing the data further, the researchers found that banks with offices located in at-risk areas were much less likely to overreact to storms and increase rates. Meanwhile, banks based in Europe—where climate change is a much bigger topic of public discourse—or that only had offices in unaffected cities like New York or Chicago were most likely to add a climate risk premium to loan rates after a storm.

Banks that didn’t overreact would drive corporate loan rates down to pre-storm levels within a few months by entering the at-risk market, offering lower rates than banks pricing in a new climate risk premium and thus stealing customers away from the climate risk-sensitive banks.

Takeaways for Banks and Businesses

Herpfer and his fellow researchers stress that there is a real risk to physical climate change in the long run—and that it will only increase as sea-level rise and rising temperatures contribute to more extreme floods and drought. However, for the current climate (financial and atmospheric), Herpfer says the research offers key takeaways for banks and businesses.

Banks:

- Think twice about updating risk assessments in at-risk areas after observing weather disasters elsewhere. The current evidence supports very little change to loan rates from the risk of physical climate change. Be particularly careful when the media amplifies the sentiment.

- Build robust risk assessment frameworks to account for cognitive biases and effectively manage climate-related risks in the financial system. The salience of climate change as a topic in public discourse can lead to misguided risk assessment.

- Rely on “boots on the ground.” Bankers with real-world experience with climate risk, based in at-risk areas, are more likely to keep a cool head through hype cycles, while preparing for longer-term physical climate change risks.

Businesses:

- Prepare for potential overreaction from banks if your firm faces climate change risks such as hurricanes, even when events happen elsewhere. Herpfer says at-risk firms are likely already doing this. Their research shows that at-risk but unaffected firms reduce capital expenditures and increase cash on hand after storms, steps that help them avoid taking on new loans during short-lived periods of increased rates.

- Develop a good relationship with a bank that has local experience and truly understands your business. Herpfer says a company operating in Texas might save on loan costs by doing business with a bank that has people based in Dallas or Houston rather than one that is based solely in New York.

“It’s surprising in the sense that these borrowers we observe are mature, large companies, and you wouldn’t think something as simple as physical proximity still matters,” Herpfer says, “but it does matter.”

Professor Christoph Herpfer is the author of “The Rising Tide Lifts Some Interest Rates: Climate Change, Natural Disasters, and Loan Pricing,” with Ricardo Correa at the Federal Reserve Board, Ai He at Darla Moore School of Business, and Ugur Lel at the University of Georgia, published in The Journal of Finance (2026).