Climate shocks and banking sector stability: Evidence from El Niño southern oscillation

This study introduces a novel ex ante approach to assess the short-term impact of climate shocks on banking sector stability by examining the effect of El Niño Southern Oscillation (ENSO) on banking sector distance-to-default. Using dynamic panel data econometric modeling, we investigate the macroeconomic implications of ENSO-induced climate shocks, such as El Niño and La Niña events, on banking sector stability in 51 countries across three regions particularly exposed to the consequences of ENSO oscillations (East Asia and Pacific, Latin America and the Caribbean, and Sub-Saharan Africa) during the period 2000–2020. Our findings show that the adverse effects of these climate shocks on banking sector stability are unevenly distributed among countries, with more pronounced and robust adverse effects of El Niño events in the short-term, particularly in Latin America and the Caribbean and, to a lesser extent, Sub-Saharan Africa. We also document the short-term adverse effects of La Niña events for Latin American and the Caribbean countries. Further estimates suggest that the increase in non-performing loans is a key transmission channel linking El Niño events to banking sector stability. As global warming should intensify the frequency and magnitude of ENSO's cyclical pattern, these findings can help estimate the potential adverse effects of climate change-related natural disasters on banking sector stability and inform future mitigation and adaptation policies.