European Central Bank working paper finds climate transition risk raises repo funding costs and alters monetary policy transmission

The European Central Bank published a working paper examining how banks’ exposure to climate transition risk is priced in the European interbank repo market. Using banks’ “financed emissions” as a proxy for transition risk, the authors find that more carbon-exposed banks face higher secured short-term borrowing costs, with the premium increasing materially in periods of financial stress and associated with uneven pass-through of policy rate changes. Using transaction-level Money Market Statistical Reporting data from 2019–2022, the study analyses around 2.3 million funding-driven, bilateral general-collateral reverse repos between 46 reporting banks (lenders) and 223 borrowing counterparties. A one standard deviation increase in financed emissions is associated with repo rates that are 7–12% higher on average (around 3–5 basis points in the preferred specifications), even after controlling for collateral, maturity, haircuts and lender–borrower relationships. The premium is larger in less standardised and riskier segments such as non-financial corporate collateral, and it intensifies to roughly three times its normal size in stressed market conditions. Mechanism tests point to a mix of credit-risk compensation and an “inconvenience premium” linked to dealer banks’ sustainability preferences, including evidence around positive haircuts, stronger pricing after Net-Zero Banking Alliance commitments, and an ETS allowance-supply shock in 2022 that coincides with a larger premium for high-emission banks. On monetary policy, the results suggest faster adjustment of repo rates for high-emission (“brown”) banks following rate hikes, with estimates indicating around 7% quicker pass-through in parts of the sample.