Climate risk and banking stability in China: A dynamic analysis from the short- and long-term perspectives

Recently, the intensifying effects of climate change and frequent extreme weather events are posing a risk to the stable development of financial markets. This study examines the short- and long-term differential impact of both physical and transition risks on bank stability, focusing on climate risks that banks face during the transition to a low-carbon economy. First, from a short-term perspective, this study finds that both types of climate risk increase bank risk, with heterogeneous effects depending on factors such as bank asset size and loan growth rate. The scale of a bank’s traded financial assets moderates the impact of transition risks. Analysis of lag effects demonstrates the long-term and complexity of transition risks. This study employs the Barunik-Krehlik (BK) spillover index model to investigate the impact of transition risk on the stable operation of banks for different time frequencies. The results reveal a time-varying spillover effect, with the long-term impact higher than the short- and medium-term effect. To mitigate the adverse impact of climate risk, we recommend several policy recommendations, including strengthening climate risk monitoring, advancing stress testing, and dynamically adjusting policy implementation plans. These suggestions provide valuable insights for maintaining China’s financial market stability and ensuring financial security.