The impact of climate risk on bank profitability through liquidity creation channel: empirical evidence from G7 countries

Abstract This study investigates the impact of climate change-induced risk on bank profitability in the G7 countries from 2001 to 2022. Using dynamic panel GMM estimation to analyse banking industry data with climate risk factors, we find that climate risk has a negative effect on bank profitability. The study also demonstrates that bank liquidity creation plays a key role in transmitting the adverse impact of climate risk on bank profitability. Additionally, the results of the study are robust and withstand different measures of bank liquidity creation. Furthermore, our empirical findings indicate that the influence of climate risk factors is consistent, even for banks primarily focussed on the insurance business. These findings suggest that policymakers may need to implement climate risk management policies to mitigate the detrimental effects of climate change on the banking sector.