Fossil fuel lending and transition risk: Evidence from provisions and credit risk capital requirements

This paper analyzes how fossil fuel lending affects bank credit risk in the European Union. The study considers expected credit losses under IFRS 9 and the capital intensity of credit portfolios captured through credit risk weighted assets. Using regulatory and financial disclosures for 2019 to 2023, we estimate fixed effects models that relate fossil fuel exposures to both measures while controlling for bank characteristics, macroeconomic conditions, and solvency positions. Our results indicate that larger fossil fuel loan shares are associated with higher expected losses and greater risk weight intensity. Stronger capital positions weaken both relationships, which indicates that solvency shapes how transition exposed lending is reflected in accounting outcomes and prudential assessments. Our analysis also highlights the influence of sectoral concentration, operating efficiency, and past credit performance. These findings carry important policy implications. Transition exposed lending should receive greater attention in supervisory reviews and in the capital strategies that banks develop to address emerging climate risks.