Using confidential information on banks’ portfolios, we show that banks that emphasize the sustainability of their lending policies in their disclosures do not exhibit a reduced environmental impact and, if anything, they extend a higher volume of credit to brown borrowers, without charging higher interest rates, shortening debt maturity, or requiring more collateral. These results cannot be attributed to the financing of borrowers’ transition toward greener technologies. Examining the mechanisms behind the strategic disclosure choices reveals that banks extend credit to existing brown borrowers, especially those who are financially underperforming. This paper was accepted by Caroline Flammer, sustainability. Funding: M. Giannetti acknowledges financial support from the Swedish House of Finance, the Nasdaq Nordic Foundation, the Karl-Adam Bonnier Foundation, and the Jan Wallander and Tom Hedelius Foundation. M. Jasova acknowledges financial support from the Barnard College Presidential Research Award. M. Loumioti acknowledges financial support from the University of Texas at Dallas. The opinions expressed herein are those of the authors and do not necessarily reflect those of the ECB or the Eurosystem. All errors are the authors’ own. Supplemental Material: The online appendix and data files are available at https://doi.org/10.1287/mnsc.2024.07420 .

Abstract We show that lender of last resort (LOLR) policy exacerbates bank interconnectedness. Using novel micro-level data, we analyze LOLR’s haircut gaps: the differences between the private market and central bank haircuts. LOLR policy incentivizes banks to increase pledging and holdings of higher haircut-gap bonds, especially those issued by domestic and systemically important banks. Effects only apply to banks, not to nonbanks without LOLR access. LOLR funding revives bank bond issuance associated with higher haircut gaps and increases the subsequent correlation between pledging and issuing banks’ bond prices, in particular during periods of low-market returns and for domestic, systemically important banks.