Does Heat Stress Deteriorate the Quality of Banks' Loan Portfolios? Evidence from U.S. Community Banks

Abstract

Climate change affects the stability of the banking sector through physical risks and poses a special threat to the performance of banks whose business is concentrated in the economy surrounding their headquarters. Among physical risks rising temperatures and heat waves stand out as the largest contributor to economic losses. We empirically examine non-performing loans from U.S. community banks between 2002 and 2021 and reveal a deterioration in the overall credit quality of institutions in heat-exposed regions. The results are relevant for banks and regulators, as they reveal exogenous locational disadvantages that could threaten exposed banks’ existence in the near future.

Keywords: Climate Change, Physical risks, Bank loan quality