Do Banks Overreact to Disaster Risk?

We examine how banks respond to natural disasters when borrowers are in proximity to affected areas. We find robust evidence that banks impose significantly higher loan spreads on firms in these areas following a disaster compared to other borrowers. This effect diminishes over time and is stronger for loans with concentrated syndicates, disasters with greater media coverage, and cases in which loan officers are geographically closer to disaster sites. The increased financing costs result in capital constraints for affected firms. Overall, our findings highlight a salience bias in banks' evaluation of borrowers' disaster risk, with adverse effects on borrowing firms.