Abstract

Climate change is increasingly acknowledged as a fundamental risk to the stability of the financial system. The linkage between residential mortgage lending and local heatwave projections has hitherto received little attention in the climate finance discourse despite recognition of the detrimental effects of extreme heat on economic output measures. Through economic, demographic and other channels, future climate conditions can affect the housing market and, thus, the residential mortgage market. Moreover, the potential for contagion is high considering US residential mortgages’ key role in financial cycles and cross-border effects. First, our paper furthers conceptual and empirical understandings of the nexus between future extreme heat and lenders’ credit risk. Second, for the contiguous US states, we show that interest rates are higher and loan terms are shorter in areas forecast to experience a larger increase in the number of hot days over the coming decades after controlling for a range of factors. Rate spreads are higher still in areas where the number of hot days is projected to be extreme. It is lending from non-banks, rather than banks, that appears sensitive to the changing climate.

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