Analyzing the effects of climate risk on discouraged borrowers: Deciphering the contradictory forces

We examine the impact of climate risk on discouraged borrowers among small and medium-sized enterprises (SMEs) in the eurozone, using a unique European Central Bank dataset focusing on the demand side of credit markets. We argue that two opposing channels may exist in this relationship: Either climate risk has a negative effect stemming from increased demand for sustainable or climate-resilient projects that enhance creditworthiness, or climate risk has a positive effect arising from heightened climate uncertainty and risk aversion, leading to credit self-rationing among SMEs. Our findings reveal that heightened climate risk prompts SMEs to self-ration credit, leading to higher probabilities of discouraged borrowers. Our research deepens the understanding of the impact of climate risk on credit-related decisions, stressing the need for proactive measures to integrate climate risk assessments into regulatory frameworks and lending practices. The findings underscore the vulnerability of SMEs to climate risk, emphasizing emphasizing the importance of tailored support mechanisms for economic resilience.