Environmental Taxation and Financial Frictions in Green Lending

<jats:p>We study polluting firms that require loans from a monopolistic bank to invest in abatement technology. Firms differ in the effectiveness of abatement investment, and this effectiveness is private information. The bank offers a screening contract under which high-cost firms receive too little capital and therefore emit excessively. A regulator restricted to tax policy responds by setting an environmental tax above marginal environmental damage, i.e., above the Pigouvian level. The first-best allocation can be restored by combining the Pigouvian tax, which ensures efficient abatement, with tailored, type-specific loan subsidies that correct the credit-market distortion.</jats:p>