The Impacts of Environmental Risks on Bank Loan Covenants and the Cost of Bank Loans

Abstract

Covenants in loan agreements and the cost of bank loans are expected to be mechanisms in banks' environmental risk management. This paper provides an in-depth examination of the associations between environmental risks and 1) bank loan covenants, and 2) the cost of bank loans in the Australian context. The examination is conducted through semi-structured interviews with senior executive bankers in major Australian banks. The results indicate that customized environmental covenants are included in bank loan agreements to manage environmental risks. The cost of bank loans will not reflect environmental risks unless these risks impact the credit ratings of borrowing firms. Although environmental risks are not a specific input of major Australian banks' credit rating models, they are a non-financial factor of expert judgment on the credit ratings. The implications for China in banks' environmental risk management are also discussed.