Investing the Banking Risk in Encounterment with Climate Change

Objective

Climate change poses an unprecedented challenge to the governance of global socioeconomic and financial systems. Our current production and consumption patterns cause unsustainable emissions of greenhouse gases (GHGs), especially carbon dioxide (CO2): their accumulated concentration in the atmosphere above critical thresholds is increasingly recognised as being beyond our ecosystem’s absorptive and recycling capabilities. The risks caused by climate change are considered to be the most serious climate risks in the next 30 years.

These risks directly impact financial stability through channels such as the destruction of collateral, assets, and physical infrastructure of banks and customers caused by extreme climate events. Increasing of banks risks due to climate change can cause financial instability that pose serioes damage to the whole economy.

Therefore, it has been the main focus of researchers and policy makers in various countries. In this research, banks risk due to climate change was investigated.

Methods

In the present study, using data from 17 Iranian banks during the period 2011-2023, using the fixed effects method and the generalized least squares (GLS) estimator, banking risk in the face of climate change was examined.

Findings

The results of the study show that climate change affects bank risk. The relationship between risk and precipitation is negative. This effect is direct for temperature. Regarding bank variables, the relationship between risk and capital adequacy is significant and direct. Given that the significance level of the variables of bank size, leverage ratio, deposit-to-asset ratio, and deposit-to-facility ratio is less than 0.05 percent, these variables affect bank risk. Since the coefficient of these variables is negative, this relationship is inverse. Also, the effect of bank risk on return on assets and cost-to-income ratio is not significant.

Conclusion

Climate change affects banks’ risk. Therefore, it is necessary for banks to strengthen their awareness of climate change risks and the physical hazards they pose.

First, for industries vulnerable to extreme climate change events, such as agriculture, real estate and other industries, when banks lend to such industries, they should consider the potential risks of environmental factors and climate change to the greatest extent possible.

Second, banks and related lending institutions should actively improve the disclosure of information on climate change-sensitive portfolios and enhance the monitoring of loan quality in climate-related industries to ensure that they can adapt to changing climate conditions.

Finally, banks should monitor the climate characteristics of different regions, take precautions on climate change issues, and deepen their understanding of related financial laws and regulations.

Coordination between the banking and insurance industries is also essential to cooperate and address the challenges of climate change. The release of accident insurance products and bank credit should be used to transfer this risk and reduce the pressure on economic agents. Similarly, increasing the penetration of insurance, reducing credit risks related to climate change, and the ability to recover quickly after disasters can be issues that need to be considered in this context.