We examine how banks manage carbon transition risk by selling loans given to polluting borrowers to less regulated shadow banks in securitization markets. Exploiting the election of Donald Trump as an exogenous shock that reduces carbon transition risk, we find that banks engage in regulatory arbitrage and use brown loan securitization to manage their exposure to carbon transition risk. Banks are more likely to securitize brown loans when carbon transition risk is high but keep these loans on their balance sheets when the risk is reduced. In addition, securitization enables banks to offer lower interest rates to polluting borrowers but does not affect the supply of green loans. Our findings are more pronounced among banks with low levels of capitalization, domestic banks, and banks that do not display green lending preferences. We discuss how securitization can weaken the effectiveness of bank climate policies.

Security design, which broadly speaking deals with the issue of designing optimal contractual mechanisms for overcoming various frictions between agents, is the subject of an extensive literature. This paper presents a review of recent work on security design and is organized around the applications of security design in various fields of finance starting with classic corporate finance applications such as capital structure and corporate governance, financial intermediation applications such as securitization and contingent capital, the interaction of market and security design, as well as emerging applications such as fintech, sustainable finance and healthcare finance. Future research is also discussed.