Climate vulnerability, macroprudential policy, and financial risk

The impact of climate change risk on global financial markets is becoming increasingly significant. This article presents the first systematic investigation of the effects of climate-related vulnerability on financial risk, using panel data from 111 countries over the period 1997–2021. Furthermore, it examines how macroprudential policy alters the relation between climate vulnerability and financial risk, which sheds light on a hitherto under-appreciated cost of climate change for the global countries. Our empirical findings indicate that climate vulnerability directly amplifies financial risk, and this relationship remains robust across various robustness checks, including time-lag effects, different estimators, and endogeneity concerns. Furthermore, the implementation of macroprudential policies mitigates the adverse impact of climate vulnerability on financial risk by enhancing financial system resilience and reducing systemic exposures. Last but not least, heightened government fiscal expenditures and elevated public debt levels are two possible channels through which climate vulnerability affects financial risk. These findings underscore the need for targeted adaptation policies and robust financial systems to mitigate the financial risks associated with climate vulnerability.