We find a positive correlation between borrowing firms’ biodiversity risk and their loan spreads. For mechanisms, we find that banks respond differently to borrowers with regulatory risk (“Perpetrators”) and physical risk (“Victims”). Specifically, banks that are often criticized for funding biodiversity-harming sectors (“Sin Banks”) impose higher spreads on Perpetrators due to their proficiency in handling such loans but charge lower spreads for Victims owing to government support. Relationship lending alleviates the negative impact of physical risk on
loan costs, but not regulatory risk. We leverage biodiversity litigation as an exogenous shock to firms’ biodiversity risk and obtain consistent results.
