Force of nature: Diverging environmental law enforcement and financial stability in Brazil and Chile

The credibility of environmental law enforcement shapes bank lending in emerging markets. Drawing on data from Brazil and Chile, this new brief from the Land and Ocean series provides insights into financial policies that align banking activity with climate goals and ensure that financial institutions become effective partners in the green transition.

Weaker enforcement can increase the flow of credit to companies with higher risk appetites, raising banks’ exposure to transition or reputational shocks once the government restores environmental standards. Stronger enforcement can prompt an orderly reallocation of credit but may also constrain the financing of smaller or more credit-dependent firms. It is essential to understand these trade-offs when designing climate-related financial policies that support both environmental integrity and macro-financial stability.

Recommendations

• Integrate enforcement credibility into financial supervision. Supervisory authorities should monitor indicators of enforcement strength – such as inspection coverage, judicial resolution times and the implementation of penalties – as part of climate and environmental risk assessments.
• Strengthen coordination between environmental and financial regulators. Regular data sharing between environmental agencies and prudential supervisors can help identify regions, sectors or institutions with rising exposure to environmental liabilities.
• Embed enforcement scenarios in climate stress testing. Financial authorities should consider institutional credibility as a variable in the design of stress tests, exploring how stronger or weaker enforcement could alter transition pathways, sectoral exposure and collateral valuation.