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Understanding drought shocks: Bank financial stability and loan performance

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  • Özsoy, S. Mehmet
  • Rasteh, Mehdi
  • Yönder, Erkan

Abstract

Unlike other climate shocks, droughts are slow and silent, and their impacts are not immediate. We define a two-year drought shock at the bank level and quantify the impact of droughts on bank stability and performance. Applying a difference-in-differences methodology, we find drought shocks to significantly worsen Z-Score, return on assets, and stock volatility. Non-performing loans of affected banks are significantly higher compared to unaffected banks. The economic impacts are comparable to those associated with a 1 % decline in unemployment rate. We also document that affected banks close branches in drought-hit regions but do not increase their capital ratios.

Suggested Citation

  • Özsoy, S. Mehmet & Rasteh, Mehdi & Yönder, Erkan, 2025. "Understanding drought shocks: Bank financial stability and loan performance," Global Finance Journal, Elsevier, vol. 65(C).
    • Handle: RePEc:eee:glofin:v:65:y:2025:i:c:s1044028325000274
    DOI: 10.1016/j.gfj.2025.101100
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    1. Valente Fernanda & Chen Yujia & Calabrese Raffaella & Cowling Marc & Alessi Lucia, 2026. "Nature-adjusted probability of default for European small and medium enterprises," JRC Working Papers in Economics and Finance 2026-01, Joint Research Centre, European Commission.
    2. Yun Zhang & Hui Ming, 2025. "Climate risk exposure and bank risk-taking behavior: new evidence from China," Humanities and Social Sciences Communications, Palgrave Macmillan, vol. 12(1), pages 1-19, December.
    3. Abinzano, Isabel & Corredor, Pilar & Mansilla-Fernández, José Manuel, 2026. "Physical climate risk and banks’ credit risk: Worldwide evidence," The North American Journal of Economics and Finance, Elsevier, vol. 81(C).

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    Keywords

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    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • Q54 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Climate; Natural Disasters and their Management; Global Warming
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • L25 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Performance
    • Q25 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Renewable Resources and Conservation - - - Water
    • Q51 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Valuation of Environmental Effects

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