Harish Kamal, Samit Paul, Avijit Bansal
Review of Finance, Volume 30, Issue 3, May 2026, Pages 949–994, https://doi.org/10.1093/rof/rfaf073
The increasing frequency and severity of climate-related shocks is one of the most important challenges we face today, as it significantly impacts economic outcomes. Recent research indicates that climate shocks adversely affect firms’ operations and financial performance. During these shocks, access to credit plays a critical role in firms’ recovery because of the incompleteness of insurance markets. Lenders, however, typically resort to credit rationing that can impede firms’ recovery, especially in less developed economies that suffer from severe frictions. Government banks (hereafter, GOBs), which are common in these economies, are created to mitigate such financial frictions. Therefore, we conjecture that GOBs may provide financial support and play a critical role in firms’ recovery during climate shocks.
The study investigates the role of firms’ exclusive relationships with GOBs (henceforth, GOB firm) during climate shocks when government aid is unavailable. This is ultimately an empirical question, as economic effects are unclear. One view is that GOBs with welfare goals may reduce the credit constraints of affected firms. The alternate view is that the poor incentives and political interference in GOBs often lead to excessive risk aversion and credit misallocation, and thus may not provide financial support to the affected firms. This conflict in the literature motivates our study.
We exploit the Indian setting to resolve this conflict for the following reasons: a) firms are exposed to large unanticipated abnormal rainfall shocks, but they lack access to disaster relief funds; b) the credit market suffers from severe financial frictions; c) banking is relationship-driven; and d) GOBs dominate the credit markets.
We find that GOB firms secure more credit compared to other firms that maintain exclusive relationships with private/foreign banks or maintain multiple transactional relationships during abnormal rainfall shocks vis-a-vis normal periods. The GOBs relationship is particularly beneficial for firms that are more vulnerable to rainfall shocks, financially constrained, have long-term banking relationships with GOBs, and, at the same time, are healthier (i.e., non-distress, less-risky, and non-zombie firms) compared to other firms. Consistent with a relationship-lending channel, we observe that GOBs extend credit only to their relationship firms (i.e., GOB firms), exploiting informational advantages during rainfall shocks. Our results are not driven by alternative channels. We find no evidence of GOBs’ politically motivated lending, GOBs’ aggregate increase in credit supply to all affected firms regardless of relationships, or differential impact on the deposits of GOBs and other banks.
With regard to real implications, we observe that GOB firms, due to ease in access to finance, increase capital expenditure, which allows them to remain profitable than other firms, during abnormal rainfall shocks.
Our study contributes to the growing literature on climate finance, as well as to the literature on the costs and benefits of maintaining banking relationships, especially with GOBs. While GOBs extend credit to healthy borrowers, traditional commercial banks hold-up and do not extend credit in response to the credit demands of their relationship firms during a climate–related shock. Overall, our results highlight the benefits of GOB relationships for firms during climate shocks.