Climate Risk and Credit Losses: A Global Perspective on Heterogeneous Impacts

This study comprehensively examines the impact of physical climate risk on credit loss rates globally. The novelty of this paper is that it uses various credit loss metrics that reflect both current and forward-looking risk, including the realised credit impairment rate, the realised loan impairment rate, the realised loan charge-off rate, and the forward-looking Merton-model credit loss rate. Climate risk is measured by the Climate Physical Risk Index (CPRI), which aggregates major climate-related hazards across countries. Using a sample of 75 countries from 2001 to 2023, we find that a 1% increase in the climate risk index is associated with a 0.17% (0.32%) increase in the charge-off rate (the forward–looking credit loss rate), while it does not affect impairment rates. Sectoral analysis shows notable increases in forward-looking loss rates for the energy and industrial sectors of about 0.32% and 0.44%, respectively, when facing heightened climate risk. Furthermore, we find that enhanced institutional quality mitigates climate risk effects in the industrial sector but not in the energy sector. These results underscore the necessity for strengthening institutional frameworks and implementing targeted policy reforms, such as climate adaptation funds, insurance mechanisms, and accelerated transitions to renewable energy, to address-sector-specific climate-related financial risks.