Climate risks and financial stability: Evidence on the effectiveness of climate-related financial policies

Abstract

This paper investigates the impact of climate-related risks on financial stability , focusing on the role of climate-related financial policies. Using a panel dataset of 88 countries from 2000 to 2020, the study examines how physical and transition risks, proxied by CO 2 emissions, climate vulnerability indices, and the Global Climate Risk Index, affect key financial stability indicators, including the Bank Z-score, non-performing loans (NPL) ratio, and liquidity ratio. By incorporating the Climate-Related Financial Policy Index (CRFPI), the analysis contributes to the literature by quantifying the effectiveness of climate-related financial policies in mitigating financial risks. The findings reveal that climate risks increase financial instability. However, countries with stronger climate-related financial policies exhibit greater financial resilience, particularly through lower NPL ratios and improved liquidity conditions. Overall, the results suggest that while CRFPI mitigates financial instability, its impact on solvency risk is less pronounced. Moreover, the effectiveness of these policies shows diminishing returns at higher levels of regulatory intensity. These findings underscore the importance of integrating climate considerations into financial regulatory frameworks while ensuring a balanced approach to policy design.

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