Does Nature Loss Raise Public Borrowing Costs?

Forests, fisheries, freshwater, and biodiversity are not only environmental resources. They also support economic activity and growth. When these natural assets deteriorate, the consequences can ripple through the economy and potentially affect the cost of government financing.

Governments are central to protecting nature. Biodiversity conservation, forest preservation, and sustainable water management provide benefits that extend across society. Private companies may have limited incentives to finance these public goods on their own, leaving governments and municipalities with much of the responsibility.

Sovereign green bonds offer one way to finance this work. Governments issue these bonds to raise money for environmental projects such as renewable energy, clean transportation, biodiversity conservation, sustainable water management, and forestry.

But do investors consider a country’s natural assets when pricing its green debt? Do environmental promises affect borrowing costs? Or do investors wait for evidence that projects have actually been implemented?

Our paper examines sovereign green bonds issued between 2016 and 2024. We also study more than 15,000 municipal green bonds to determine whether the findings extend from national to local public finance. In addition to bond-market information, we use issuers’ green bond frameworks, allocation reports, and impact reports to distinguish between governments’ stated intentions and their subsequent efforts.

Three findings stand out.

First, nature-related risks are associated with the cost of public green debt. Sovereign green bond yields are higher when countries score higher on the paper’s measures of biodiversity and natural-capital risk. This relationship appears both when bonds are issued and when they subsequently trade in financial markets.

We also compare green bonds with similar conventional bonds issued by the same government. The association between natural-asset risk and yields is generally stronger for green bonds, particularly in the secondary market. This is consistent with these risks being especially relevant for securities intended to finance environmental projects.

The municipal bond evidence points in the same direction. State-level measures of endangered bird species are positively associated with municipal green bond yields. Nature-related risks may therefore matter not only for national governments but also for state and local public finance.

Second, investors appear to distinguish between environmental promises and implementation.

When issuing a green bond, a government typically publishes a framework outlining the types of projects it intends to finance. Many sovereign frameworks include biodiversity conservation or natural-resource management. However, simply listing these objectives is not significantly associated with lower bond yields. We find a similar result for bonds linked to the United Nations Sustainable Development Goals, specifically Life Below Water (Goal 14) and Life on Land (Goal 15).

The results differ when governments report on actual project implementation. A larger number of green projects relative to the proceeds raised is generally associated with lower yields. This pattern is consistent with investors placing greater weight on reported action than on stated commitments alone.

The distinction has an important implication for sustainable finance. Issuing a green bond and announcing eligible project categories are only the beginning. Allocation and impact reports enable investors to see how proceeds are used and whether projects move forward.

Third, the paper examines whether measurable environmental improvements accompany green financing.

We do not find a statistically significant relationship between governments’ interim or net-zero targets and changes in per-person carbon emissions over the following three years. Broad climate commitments, by themselves, are therefore not accompanied by clear improvements in this measure.

The forestry results are more encouraging. Approximately 40% of the sovereign green bonds in our main sample support sustainable forestry. In countries that finance these projects, the years following green bond issuance are associated with increased forest area and reduced forest-cover loss. Although these findings should be interpreted as associations, they suggest that examining outcomes tied to specific projects may be more informative than evaluating broad commitments alone.

Our study contributes to sustainable finance in two ways. First, it expands the discussion beyond climate risk to include biodiversity and the depletion of natural resources. Second, it shifts attention from corporate securities to public debt, where governments have both a responsibility for protecting natural assets and a need to finance that protection.

The main message is straightforward. Nature-related risks are associated with public borrowing costs, while environmental promises alone contain limited pricing information. What appears to matter more is whether governments translate their commitments into observable projects and outcomes.

For governments entering the green bond market, the green label is a starting point. Implementation is what gives that label substance.

The authors’ complete article can be accessed here.

Jitendra Aswani is a Postdoctoral Associate at the MIT Sloan School of Management.

William W Xiong is an Assistant Professor of Finance at Binghamton University (SUNY).