Uncertainty Unveiled: The influence of uncertainty on firms’ credit risk and capital needs

Abstract

This research examines the interactive roles of financial information, climate policy, and economic policy uncertainties on the overall financial system and, more notably, the credit policies of firms. In this dissertation, we consider quantitative methods based on empirical evidence to analyze how the flow of information, particularly from the European Central Bank, impacts lending practices within financial institutions. In parallel, we analyze the potential impact of climate policy uncertainty, even under the most adverse climate change scenarios, on the capital requirements of global firms. Moreover, we discuss the multifaceted relationships between economic policy uncertainty and extend it further to understand its implications for worsening corporate credit risks and disruptions of financial stability. With this research, we provide policymakers, central and national banks, investors, and other relevant stakeholders with important findings that will aid them in managing global risks. We analyze how different types of uncertainty (financial information, climate policy, and economic policy uncertainty) influence global credit markets and financial stability. Therefore, we offer useful recommendations for policymakers, financial institutions and firms’ managers to mitigate economic and environmental risks more successfully. Our findings can be applied to refine and enhance risk management frameworks and prepare firms to respond to financial challenges in the future. In Chapter 2, we construct a new index of information (Info Index) based on the ECB’s public statements (speeches, conference discussions and media interviews), we show that increased access to financial information leads to abatement on banks’ lending. We conclude that European Central Bank announcements, except those that address transparency and clarity of monetary policy, also affect banking credit policy. Our findings have important implications for policymakers in their work to avert real economic shocks, as well as for bank managers who must react to financial information to maximize the effectiveness of their credit policies. In Chapter 3, we show that climate policy uncertainty affects the future capital shortfall of global financial firms. Under a severe climate scenario, firms will need 11.28% more marginal capital and 7,63% more total capital. After the signing of the treaty of the Paris Agreement, the effect has been stabilized at the global level. Our results support this outcome by presenting evidence that, after the agreement, the marginal capital needs fall by 10.22% and the total capital needs fall by 4.22%. Τhere are strong indications that the USA’s withdrawal from the agreement increased the climate capital needs for USA firms. Notably, these firms now face higher capital requirements due to increased uncertainty surrounding climate policy in the country. Our results have significant implications for regulators, as they are related to the stability of the financial system under a significant climate stress scenario. By recognizing the potential for increased capital needs in the face of climate uncertainty, regulators can better assess and mitigate risks to the financial sector. This research underscores the importance of addressing climate change comprehensively and implementing consistent climate policies to encourage financial stability. Finally, Chapter 4 provides significant insights into the complex relationship between economic policy uncertainty and the financial stability of enterprises. Our research indicates that when there is a higher degree of ambiguity in government policies, it leads to an increase in the risk of default for companies. Under a severe uncertainty scenario, an increase of one unit in policy uncertainty leads to a proportional decrease in enterprises' Distance to Default (DtD). Furthermore, our analysis shows that the influence of policy uncertainty on the credit risk of companies differs across industries. Financial markets and regulatory laws are highly responsive to fluctuations in economic policy uncertainty, which increases the level of credit risk for companies participating in these industries. Our results support this outcome by presenting evidence that, a one standard deviation rise in policy uncertainty results in a decrease in DtD for the technology industry which affected more than the others. This research highlights the need of dealing with economic policy uncertainty in order to sustain financial stability. By recognizing the potential implications of policy uncertainty on firms' credit risk, policymakers, investors, and corporate managers can adopt proactive measures to mitigate risks and enhance resilience in the face of uncertain economic conditions.