We investigate whether lending institutions in China incorporate harmful gas emissions into their credit decision-making processes – specifically, whether they penalize firms with higher levels of pollutants by increasing debt financing costs. The study highlights the importance of managing harmful gas risks for enterprises to avoid financing difficulties. We use SO₂ emission intensity at the firm level as a proxy for harmful gas emissions. We select our sample firms from Chinese industrial firms from 2005 to 2013. Using a two-way fixed effects model and a three-step U-test, we find that a U-shaped relationship exists between firms' SO₂ emission intensity and debt financing costs. When SO₂ emission intensity is low (<0.126), the risk of debt default due to environmental risks is low, and further efforts to reduce emissions may lead to inefficient resource allocation, elevated costs, and increased operational risks, prompting creditors to raise debt costs. When SO₂ emission intensity is high (>0.126), increased regulatory, abatement, and compliance costs amplify operational and default risks, leading creditors to penalize firms with higher debt financing costs. This U-shaped relationship is particularly obvious in private firms, firms located in non-coal resource cities, and non-SO₂ or non-acid rain control zones. Instrumental variable estimation is used to address endogeneity, while robustness is verified through alternative explanatory and outcome variables. The volatility of firms' earnings is further analyzed as a channel through which sulfur dioxide emission intensity affects the costs of debt financing. Additionally, firms' carbon risks, measured by calculating emissions from fossil energy consumption, also exhibit a U-shaped relationship with debt financing costs. These results suggest that in addition to business risks, firms incorporate the environmental risks of their business into their lending decisions and that financial instruments are an important environmental regulatory tool.