Firms' borrowing costs and neighbors' flood risk

This study examines whether Italian firms exposed to physical climate risks incur additional borrowing costs due to spatial spillovers. Using a sample of 419,040 firm-year observations from 2016 to 2019, we find a positive relationship between a firm's cost of debt and its neighborhood's average exposure to climate risk. According to our findings, the costs associated with neighborhood climate risk are as relevant as those associated with a firm's direct risk, with small businesses being the only ones affected by spillover effects. These results may be explained by small enterprises' lack of financial diversification, poor bargaining power, and strong reliance on credit from financial intermediaries. Climate change promises to be massively expensive, which is already altering the financial landscape for businesses in many countries. Prior investigations into the effects of climate-induced phenomena (e.g., floods and severe weather) on borrowing costs have revealed that firms in flood-prone zones are subjected to heightened loan expenses. The burden is disproportionately heavier on smaller enterprises, which are more adversely affected by the economic repercussions associated with proximity to high-risk areas. With a focus on Italy, this study highlights the financial strain climate change imposes on businesses, emphasizing how smaller companies-crucial to local economies-face amplified risks, which could exacerbate economic inequality in areas vulnerable to climate threats. There is a pressing need for precise policy measures to safeguard and aid these at-risk businesses. Implementing such policies is vital for fostering more resilient local economies that are better prepared to navigate the financial complexities induced by climate change.