Abstract

This paper explores how climate change affects bank fragility. The main results show that both physical and transitional climate changes lead to substantial increases in systemic risk. The effect is more pronounced for banks with higher climate change exposure, higher loan portfolio synchronicity, and higher bank default probability. These results are robust to using an instrumental variable approach. Further, by exploiting staggered adoptions of climate adaptation policy across states, this study documents that climate adaptation can reduce systemic risk caused by climate change. Overall, the findings in this paper provide suggestive evidence that climate change exacerbates financial instability, but adaptation policy can build resilience to climate impacts.