Climate Change, Bank Fragility, and Systemic Risk

Abstract

We examine how climate change affects bank fragility. We find both physical and transitional climate changes lead to substantial increase in systemic risk. The effect is more pronounced for banks with higher climate change exposure, higher loan portfolio synchronicity, and higher bank default probability. Our results are robust to using an instrumental variable approach and to using various alternative measures. Further, exploiting staggered adoptions of climate change adaptation across states, we find that climate adaptation actions lessen systemic risk due to climate change. Our findings provide suggestive evidence that climate change exacerbates financial instability, but adaptation can build resilience to climate impacts.

Keywords: climate change, financial stability, systemic risk, bank default risk, climate adaptation, climate resilience, bank fragility

JEL Classification: G15, G32, G38, Q54