located in the 5,659 Brazilian municipalities.<sup>20</sup> RAIS firms’ characterization includes their economic activity (CNAE 2.0), and the municipality where the firms operate. Since both data sets identify administrative divisions and use the same classification for tagging firms’ economic sectors, we could combine them. We assume that establishments with similar size within the same economic sector and administrative division exhibit similar bank indebtedness. Therefore, we distributed the credit outstanding within federal units and economic sectors according to the establishments’ sectoral share of active employees.<sup>21</sup> Finally, we summarize geographic and financial information at the municipality level. Our binding restriction to undertake a geographic-location-specific analysis is the availability of comprehensive georeferenced information on firms (and establishments) across the Brazilian territory and their credit outstanding with the banking sector.<sup>22</sup> Therefore, by aggregating the establishments’ credit outstanding, we can estimate the amount of loans that banks allocate to each municipality. Next, we weigh the municipalities' loan allocation by the proportion of municipalities’ surface covered by protected areas, and priority areas that do not overlap with protected areas. This provides us with an estimation of the banks’ exposure to transition risks through corporations that might already be operating in protected areas or in biodiverse areas that could become protected in the coming years. For instance, assume that 5 percent of the municipality “A” surface is covered by protected areas, and that banks have an outstanding credit portfolio of BRL 100 allocated in the municipality “A.” Then, Brazilian banks' credit exposure to transition risks in municipality “A” is BRL 5.

Having municipalities as our unit of the analysis entails unavoidable caveats as municipalities’ size varies considerably across the country. For instance, the municipality of Altamira (Pará) is the largest in Brazil, with 159,533 square kilometers or 45 thousand times larger than the smaller one, Santa Cruz de Minas (Minas Gerais). The larger the municipality, the larger the probability of our estimation error.

# _Environmental controversies_

Banks face reputational risks when they finance projects that have a negative impact on the environment, especially when the latter are involved in public controversies such as oil spillages or extensive deforestation. The reputational impact is assumed to be greater when the firms are found to have inadequate systems to manage the environmental footprint of their operations. This risk is being increasingly recognized by banks and financial institutions, as information about high-profile environmental degradation becomes part of the investment decision making of

> 20 The 2019 RAIS contains a universe of 7.9 million facilities. We excluded from our sample financial sector facilities and those that did not have employees or kept their activities idle during 2019. After data cleaning, we ended up with 3.9 million establishments, employing a total of 46.5 million active employees.

> 21 In other words: L L i i E E E E i <u>i</u> , where L L i ∑ E E E iiE i ~~�~~ establishment that operates in the sector ii<sup>= LL∗�</sup> NNiii=1 and federal unit ii ii . ii<sup>denote the credit outstanding of the</sup>

> 22 Studies such as DNB (2020) or others related to climate-related risks (e.g., <u>NGFS 2020a) use data from Four Twenty</u> Seven to identify business locations. However, its coverage for Brazil is significantly limited. ii ss ff

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