Cityscape transforming into a green landscape, showing the impact of carbon pricing.

Carbon Prices and Your Credit: How Climate Change Policies Affect Your Financial Health

Kai Mendoza in Climate & Environment December 2025 • 4 min read.

"Navigating the transition to a low-carbon economy: Understanding the impact of carbon pricing on credit portfolios and personal finances."

Climate change is no longer a distant threat; it's an evolving reality that's starting to touch every aspect of our lives, including our financial well-being. Governments worldwide are implementing policies to transition to low-carbon economies, and one of the most talked-about tools is carbon pricing. But what exactly is carbon pricing, and how does it trickle down to affect things like your credit score, your ability to get a loan, or the stability of your investments?

Carbon pricing essentially puts a cost on greenhouse gas (GHG) emissions, encouraging businesses and individuals to reduce their carbon footprint. This can take the form of a carbon tax, where a direct fee is levied on emissions, or a cap-and-trade system, where a limit is set on overall emissions and companies can buy and sell emission allowances. The intention is clear: to make polluting activities more expensive and incentivize cleaner alternatives.

However, these policies don't exist in a vacuum. They ripple through the economy, affecting various sectors and, ultimately, influencing the credit risk associated with lending to businesses. Credit risk, in simple terms, is the possibility that a borrower will default on their debt. As carbon pricing changes the economic landscape, it's crucial to understand how these changes propagate through credit portfolios and what it means for your financial health.

How Does Carbon Pricing Affect Credit Risk?

Cityscape transforming into a green landscape, showing the impact of carbon pricing.

Researchers are actively exploring how the climate transition, driven by carbon pricing, affects credit portfolios. A recent study adapts a stochastic multi-sectoral model to analyze how carbon price dynamics influence credit risk measures, such as the probability of default and expected losses. Here’s the breakdown:

The model considers the GHG emissions costs of sectoral firms' production, consumption, and household consumption. These costs are determined by carbon prices (often sourced from Network for Greening the Financial System - NGFS transition scenarios) and the amount of GHG emissions.

Sector Sensitivities: The model reveals how sensitive different sectors are to carbon prices, showing the relationships between them.
Short-Term vs. Long-Term: Unlike standard Integrated Assessment Models, this approach analyzes short-term effects, providing a more immediate understanding of the impact of carbon pricing.
Firm Valuation: By using a Discounted Cash Flows methodology, researchers can compute firms' values and combine them with a structural credit risk model. This helps illustrate how carbon prices impact credit risk measures.

The study highlights that carbon pricing can distort a firm's value, increase banking fees for clients (due to higher provisions for expected losses), and reduce banks' profitability (due to the economic capital needed to cover unexpected losses). Randomness in the model allows for considering uncertainties in sector productivity and different transition scenarios.

What Does This Mean for You?

The transition to a low-carbon economy is inevitable, and understanding its financial implications is crucial. As carbon pricing becomes more widespread, it's essential to be aware of how these policies might affect your investments, loans, and overall financial stability. Staying informed and adapting to these changes will be key to navigating the evolving economic landscape.

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Everything You Need To Know

What is carbon pricing and how does it function within the context of climate change policies?

Carbon pricing is a strategy where a cost is assigned to greenhouse gas (GHG) emissions, aiming to reduce carbon footprints. This can manifest either as a carbon tax, a direct fee on emissions, or a cap-and-trade system. In a cap-and-trade system, there is a limit on total emissions and companies trade emission allowances. The goal is to make polluting activities more costly, encouraging cleaner, more sustainable practices in the market.

How can carbon pricing affect my creditworthiness and financial health?

Carbon pricing policies influence the economy, which has various impacts, including credit risk associated with lending to businesses. Because carbon pricing changes the economic landscape, it can impact your ability to secure loans and the value of your investments. Changes in the economic landscape affect credit risk, that means the possibility of a borrower failing to repay their debt, so understanding how these economic shifts relate to your financial health is essential to adapt to the market changes.

How do macroeconomic models help predict the impact of carbon pricing on financial markets and credit risk?

Macroeconomic models use diverse methods to predict the influence of carbon pricing on financial markets and credit risk. For instance, a study adapted a stochastic multi-sectoral model to examine the dynamics of carbon prices and their impact on credit risk measures, such as the probability of default and expected losses. The model assesses the GHG emissions costs of sectoral firms' production, consumption, and household consumption, considering the carbon prices from Network for Greening the Financial System (NGFS) transition scenarios and GHG emissions quantities. The model analyzes sector sensitivities and short-term effects, offering insights into firm valuation and credit risk implications by using Discounted Cash Flows methodologies.

What are the key elements of the model used to analyze carbon pricing's impact on credit risk?

The model focuses on several critical elements. It considers the costs related to GHG emissions of businesses. Sector sensitivities are examined to reveal the relationships between sectors. Unlike Integrated Assessment Models, this approach analyzes short-term effects, giving a more immediate understanding. Using a Discounted Cash Flows methodology, researchers can compute firms' values and combine them with a structural credit risk model.

What are the specific financial implications of carbon pricing on businesses, and ultimately, on banks and consumers?

Carbon pricing can have several financial implications. It can distort a firm's value and can increase banking fees for clients due to higher provisions for expected losses. Moreover, it may lead to reduced banks' profitability because of the economic capital needed to cover unexpected losses. The changes in firm valuation will impact the credit risk. As carbon pricing becomes more widespread, staying informed and adapting to these changes will be key to navigating the evolving economic landscape.