N°25-75: Climate Transition Risks and Bank Liquidity Creation: Adapting to Regulatory Shocks

We examine how climate transition risks affect bank liquidity creation using the 2004 U.S. NOx Budget Trading Program (NBP)—a cap and-trade regulation affecting 11 states—as a quasi-natural experiment. Banks in NBP-affected states curtailed liquidity creation, primarily through balance sheet adjustments: reduced lending and risky asset holdings, and increased off-balance sheet exposures. Beyond this mechanism, banks adopted strategic responses to earnings pressure, including slower net interest income growth, greater noninterest income, and expanded derivative use. The effect is stronger for large, riskprone, profitable, and diversified banks, as well those in competitive markets and Democratic-leaning states. Governance matters: banks with higher common ownership are more resilient, while both shortand long-term investor horizons are associated with reduced liquidity creation—especially under shortterm ownership. Results are robust to matching, placebo tests, spillover adjustments, and event-study designs. Overall, climate regulation reshapes bank intermediation through portfolio rebalancing and strategic adaptation, with critical implications for financial stability and climate policy.