Do Banks Overreact to Disaster Risk?

We examine how banks respond to large natural disasters when corporate borrowers are located in the neighborhood of the disaster area. We find robust evidence that banks charge significantly higher loan spreads for firms located in the neighborhood of the disaster area than for remote firms. The results are not driven by regional spillovers, limited credit supply, lender rent extraction motive, or rational learning. We also find that banks’ reaction is transitory, and is less pronounced for experienced banks. Overall, our empirical findings indicate that banks are subject to salience bias when assessing their clients’ natural disaster risk.