Faculty of law blogs / UNIVERSITY OF OXFORD

Greening the Economy: How Public-Guaranteed Loans Influence Firm-Level Resource Allocation


Bruno Buchetti
Assistant Professor, University of Padua and Toulouse Business School
Salvatore Perdichizzi
Associate Professor of Finance, University of Padua
Ixart Miquel-Flores
Researcher at the Frankfurt School of Finance & Management; Banking Supervision Analyst at the European Central Bank
Alessio Reghezza
Financial Stability Expert, European Central Bank

‘The misalignment with the EU climate transition pathway can lead to material financial, legal and reputational risks for banks. It is therefore crucial for banks to identify, measure and most importantly manage transition risks, just as they do for any other material risk. […] it is not for us supervisors to tell banks who they should or should not lend to. However, we will continue insisting that banks actively manage the risks as the economy decarbonises. And banks cannot do this without being able to accurately identify transition risks and how they evolve over time.’

(Frank Elderson, member of the ECB Executive Board and Vice-Chair of the Supervisory Board, ‘Failing to plan is planning to fail: Why transition planning is essential for banks’, 23 January 2024)


Will we ever be able to efficiently channel bank funding towards green investment? Why does it seem so difficult? Our research explores the reasons why banks continue to support companies reliant on fossil fuels and looks into the impact of public guaranteed loans (PGLs) in diverting funds toward more environmentally friendly economic pursuits, aiding in the transition to a climate-friendly economy. Utilizing a distinctive dataset from a pan-European credit registry, this study integrates banking supervisory data with data on companies' greenhouse gas emissions and financial records.

Our findings highlight three key points. First, EU banks’ view lending to environmentally friendly (‘green’) companies as more hazardous compared to lending to traditional (‘brown’) firms, a situation we describe as ‘green-transition risk’. Second, the study finds that throughout the COVID-19 pandemic, European banks strategically used PGLs to direct resources towards green initiatives, thereby increasing the share of green loans in their portfolios and effectively transferring some of the green-transition risk to European governments and the public. Third, our research indicates a banking preference for granting PGLs to financially stable green companies rather than to less profitable, highly indebted green companies, a trend that might hinder the ability of financially needy green enterprises to obtain support during the COVID-19 crisis.

Over the last few years, policymakers, governments, and supranational institutions have devoted increasing attention to environmental factors, introducing ad-hoc regulations and initiatives aimed at reducing CO2 emissions. All of these initiatives share the overarching goal of combating climate change and protecting human well-being. Achieving a carbon-neutral economy necessitates fundamental shifts in our existing economic structures. Transitioning to renewable energy systems requires comprehensive changes across various sectors. It involves the development and deployment of new technologies, infrastructure upgrades, changes in energy production, distribution and consumption patterns. It also entails promoting energy efficiency and implementing policies that incentivize the adoption of renewable energy solutions. This process needs to be facilitated through channelling investment through tilting investment decisions and incentives at the equilibrium.

Such a shift necessitates extensive modifications in economic frameworks, including the adoption of renewable energy sources, infrastructure enhancements, and the introduction of energy-efficient measures. Banks are positioned to play a pivotal role in this transformation by directing funds and penalizing firms that do not adhere to environmental benchmarks, particularly in Europe where corporate financing is predominantly bank-driven. However, banks continue to finance a substantial number of enterprises reliant on fossil fuels. This paper examines the dilemma faced by financial institutions, torn between the push for green financing, driven by regulatory mandates and sustainability objectives, and the hurdles it presents, such as unfamiliarity with climate policies and the concealed expenses associated with more eco-friendly technologies and initiatives. These challenges complicate fund reallocation, risk assessment, and capital distribution.

The study delves into why banks might prefer financing more traditional, ‘browner’ firms. We suggest that the reluctance to shift towards greener investments may stem from the perceived elevated risks linked with green financing, leading to heightened capital allocation and monitoring expenses. We refer to this as ‘green-transition-risk,’ where banks view engagements with eco-friendly firms as riskier than with their less environmentally conscious counterparts. To examine this, we assess the default probabilities (PDs) for companies within identical industry-location-size (ILS) clusters, comparing them based on their greenhouse gas (GHG) emission intensity. Furthermore, we explore a potential remedy to lessen the green-transition-risk and incentivise green financing. We propose that Public Guaranteed Loans (PGLs) could enable banks to move their portfolios towards more sustainable firms by offering a safeguard against the increased default probabilities. The PGL model ensures that banks are not solely responsible for the heightened risk of default when financing eco-friendlier businesses, as the government absorbs this risk. This incentivizes banks to extend more credit to sustainable enterprises, thereby aligning their lending practices with the expectations of regulators and policymakers concerning climate and environmental risks. We also examine the allocation of PGLs to more sustainable companies during the COVID-19 pandemic.

Our analysis yields two primary findings. Firstly, PD estimations within the same ILS cluster show that greener firms have higher PDs than their more polluting counterparts, confirming the presence of green-transition-risk. Secondly, at the onset of the pandemic, there was a noticeable preference for allocating PGLs to less polluting companies, supporting our theory. We also observe an improvement in lending to greener firms that received PGLs compared to more traditional firms, along with a higher likelihood of forming new banking relationships with less polluting companies via PGLs.

Our research underscores the predicament faced by financial institutions, which are motivated to pursue green lending to achieve sustainability targets and comply with regulatory demands but are hindered by the perceived riskiness of such investments. This risk perception is fuelled by uncertainties and potential hidden costs linked to green technologies and initiatives, alongside the evolving nature of climate policies which lack consistent predictability. These uncertainties hinder banks' capacity to evaluate and manage climate-related risks effectively, influencing investment decisions, elevating capital costs, and restricting support for low-carbon ventures. In essence, banks are caught between the incentives for green lending and the perceived risks that accompany it, due to uncertainties in future developments and costs associated with eco-friendly technologies and projects.

The paper argues that introducing green public guarantee lending frameworks could mitigate these barriers and shift market dynamics to a new equilibrium, where green lending becomes more competitive and achieves better outcomes. Our findings are crucial for European policy makers. By strategically utilising PGLs, governments can alter banking practices to foster the growth of sustainable industries and advance the decarbonisation of the global economy. Our research enriches the dialogue on how the banking sector and governmental interventions, via PGLs, can facilitate the ecological transition. The examined large-scale guarantee schemes, designed to uphold private credit during the COVID-19 crisis, underscore the dual role of public credit guarantees: as a reaction to shocks impairing economic fundamentals and as an incentive for potentially credit-restricted businesses under normal circumstances. The success of PGLs in promoting the green transition hinges on the adeptness of policy makers in crafting and implementing these government-supported credit guarantees. It is crucial to strike a delicate balance: policymakers need to incentivize banks to fund eco-friendly enterprises without promoting excessive risk-taking, which could, if over-relied upon, strain public finances and impact European citizens. Policymakers are advised to set forth suitable eligibility conditions, oversight processes, and pricing strategies for loans to ensure PGLs benefit the intended entities without unnecessarily heightening the risk profile of the banks' lending portfolios.


Bruno Buchetti is an Assistant Professor at University of Padua and Toulouse Business School, Salvatore Perdichizzi is an Associate Professor of Finance at the University of Padua, Ixart Miquel-Flores is a Banking Supervisor at the European Central Bank as well as a Doctoral Candidate in the finance department at Frankfurt School of Finance & Management, and Alessio Reghezza is a Financial Stability Expert at the European Central Bank.


With the support of