Climate risk exposure and bank risk-taking behavior: new evidence from China

Abstract This paper examines how physical and transition climate risks affect the risk-taking behavior of local commercial banks in China. We construct novel measures of physical risk from high-resolution meteorological data and transition risk from a new China-specific policy uncertainty index. Panel data regressions show that exposure to both risk types significantly elevates banks’ passive risk, active risk-taking, and overall insolvency risk. The economic effects are substantial: a single additional day of extreme rainfall increases system-wide non-performing loans by over 710 million CNY. Our findings are robust to a comprehensive set of checks, including using alternative sample selections, dynamic panel models, and an instrumental variable analysis. Further analysis of the transmission channels shows that the 2016 Paris Agreement reduced bank risk-taking, greater regional banking competition mitigates climate risk shocks, and climate risk is transmitted to banks by damaging the financial health of firm borrowers. These results highlight the critical role of climate-aware financial regulation and market structure in building a resilient banking system.