Working Paper

Banking on Deforestation: The Cost of Nonenforcement

Abstract: Despite surging environmental laws, how their enforcement influences banks’ management of climate risks remains underexplored. Using the Brazilian Amazon as a laboratory, we examine the impact of a shock to environmental law enforcement capacity on bank management of risks arising from deforestation — a significant but understudied climate risk. After enforcement declined, Brazilian banks significantly altered their priorities to more short-term profitability over longer-term risk concerns. Banks greatly increased lending to agribusinesses engaged in deforestation and actively shifted resources to regions with higher deforestation potential. Results suggest that without rigorous enforcement, banks may fail to fully internalize deforestation risks, despite existing environmental laws.

Keywords: environmental law enforcement; climate risk; deforestation risk; banking; financial institutions; bank credit; Brazilian Amazon; sustainable finance;

JEL Classification: D72; G11; G18; G21; Q50; Q54;

https://doi.org/10.21799/frbp.wp.2024.21

Bibliographic Information

Provider: Federal Reserve Bank of Philadelphia

Part of Series: Working Papers

Publication Date: 2024-12-05

Number: 24-21