Â鶹ÒùÔº

Climate shocks, such as extreme weather events, have disastrous consequences for the livelihoods and economic well-being of affected communities. The banking sector can be an important lever to increase resilience. But how? Research from Maastricht University provides answers.

In the De Economist journal, economist Vinzenz Peters provides a of 76 relevant empirical studies on how banks are affected by natural disasters and how banks mediate the consequences for the real economy.

Disasters threaten both bank stability and profitability—but, so far, the effects are mostly transitory.

Disasters have been shown to have significant negative impacts on banks' balance sheets. However, for banks located in countries with developed economic and financial systems and that are well-capitalized, the negative effects are typically short-lived, and financial institutions recover quickly.

Stringent regulation and capital requirements benefit the resilience of banks through disastrous shocks, and no single event has (so far) posed a crucial threat to the stability of the banking system as a whole.

Evidence from developing countries raises concerns about the feasibility of Sustainable Development Goals.

In the context of developing economies, however, severe shocks have longer-lasting impacts on bank health, increasing financial risks and stunting bank profitability. Consequently, these banks struggle to provide credit in the aftermath of shocks. This exacerbates the economic problems for disaster-affected households and firms in these countries: Without credit, they often lack the resources to rebuild and recover their livelihoods.

"We know that economic development is one of the best predictors of economic resilience to shocks. Richer countries have the resources to bounce back, while poorer countries do not. The financial sector is one channel that amplifies this problem. Weaker banks that are less well capitalized cut off credit, prolonging the struggle to recover in disaster-stricken regions," says Peters (Maastricht University).

A trade-off between efficiency and resilience?

The research also highlights a potential trade-off that policymakers and societies as a whole need to consider: Features of the banking system that are typically associated with higher efficiency (such as high competition, privatization, automation of credit decisions) were found to hinder resilience in times of crisis.

For instance, regions with more traditional, locally focused and smaller banks (such as cooperative banks in Europe or community banks in the US) are, on average, more resilient. Although these banks are often more vulnerable themselves because of their local focus, they appear more committed to channeling credit flows to disaster-affected borrowers in their areas of operation.

Similarly, state-owned banks that are shown to be less efficient and profitable, often engage heavily in recovery financing, with positive effects on local economic resilience. Purely profit-maximizing banks, however, do not seem to generate these benefits, at least not to the same extent.

"There seems to be a trade-off between a system that is geared towards efficiency and profitability in non-crisis times and a system that enhances the resilience of the economy in times of crisis. As climate-related disasters become more frequent and intense, regulators and policymakers may need to rethink the design of our banking systems in light of this evidence."

"In the face of climate change, people need banks that also lend when it rains, not just when the sun shines," says Peters.