Financial Risks in Flooding: Bank Response to Climate-Induced Natural Disasters

To assist regulators and policymakers in monitoring climate-related risks in the financial system, I study whether banks are tailoring their mortgage lending strategy to manage the risk of rising occurrences of flood natural disaster events. Using a novel research design, this study seeks to determine whether financial institutions reduce financial exposure to communities with high flood disaster risk by either reducing residential mortgage originations, increasing mortgage sales, or increasing the share of higher-priced mortgages originated. My empirical strategy expands the existing literature which has not explicitly incorporated information from the frequency and magnitude of past flooding events on ex-ante flood risk within a county into the bank decision-making process. Results suggest that the average mortgage lender decreases acceptance rates, increases the sale of mortgages, and increases the origination of higher-priced mortgages in response to high flood risk. These results are most pronounced when considering nonlinearities in the number of recent floods and interactions with the magnitude of flood damage. Heterogeneity analysis reveals that commercial banks, originate-to-hold banks, and banks operating with lower financial stress have stronger responses to flood risk compared to credit unions, independent mortgage banks, originate-to-distribute banks, and banks with higher levels of risk. I support ongoing efforts by financial regulators to monitor climate-related financial risks which will become more poignant as the trend in climate-induced natural disasters increases over time.