This study examines whether and when banks incorporate borrowing firms’ biodiversity risk into their loan decisions. We find a positive correlation between biodiversity risk disclosed in 10-K reports and loan spreads. To explore the mechanisms, we show that both regulatory and physical biodiversity risks are associated with higher loan spreads, but banks’ responses to these two types of risks differ. Specifically, top biodiversity-financing banks penalize Perpetrator firms with regulatory risk but support Victim firms with physical risk. Relationship lending can mitigate the negative impact of physical risk on loan costs but not regulatory risk. Together, these findings highlight banks’ nuanced roles in biodiversity finance. For causal inference, we use biodiversity litigations as exogenous shocks to firms’ biodiversity risk and obtain consistent results. We also show that the influence of biodiversity risk on loanspreads is distinct from that of climate change and other environmental risk.
