Risks on Global Financial Stability Induced by Climate Change

Abstract

There is increasing concern among financial regulators that changes in the distribution and frequency of extreme weather events induced by climate change could pose a threat to global financial stability. In order to assess this risk, we develop a simple model of the propagation of climate-induced shocks through financial networks. Weshow that the magnitude of global risks is determined by the interplay between the exposure of countries to climate-related natural hazards and their financial leverage. Climate change induces a shift in the distribution of impacts towards high-income countries and a thus larger amplification of impacts as the financial sectors of high-income countries are more leveraged. Conversely, high-income countries are more exposed to financial shocks. In high-end climate scenarios, this could lead to the emergence of systemic risk as total impacts become commensurate with the capital of the banking sectors of countries that are hubs of the global financial network. Adaptation policy, or the lack thereof, appears to be one of the key risk drivers as it determines the future exposure of high-income countries.