The public costs of climate-induced financial instability

Abstract

Recent evidence suggests that climate change will significantly affect economic growth and several productive elements of modern economies, such as workers and land1–4. Although historical records indicate that economic shocks might lead to financial instability, few studies have focused on the impact of climate change on the financial actors5,6. This paper examines how climate-related damages impact the stability of the global banking system. We use an agent-based climate–macroeconomic model calibrated on stylized facts, future scenarios and climate impact functions7 affecting labour and capital. Our results indicate that climate change will increase the frequency of banking crises (26–248%). Rescuing insolvent banks will cause an additional fiscal burden of approximately 5–15% of gross domestic product per year and increase the ratio of public debt to gross domestic product by a factor of 2. We estimate that around 20% of such effects are caused by the deterioration of banks’ balance sheets induced by climate change. Macroprudential regulation attenuates bailout costs, but only moderately. Our results show that leaving the financial system out of climate–economy integrated assessment may lead to an underestimation of climate impacts and that financial regulation can play a role in mitigating them. Increasingly, financial institutions will be exposed to climate risks that will exacerbate the negative economic impacts of climate change. An agent-based integrated assessment model is used to analyse climate impacts on the global banking system, finding an increase in banking crises and public bailout costs.