Decoding the Link of Climate Risk and Banking Stability: An Analysis Through the Lens of Climate Uncertainty and Banking Regulation During the Pre- and Post-Paris Accord

Abstract

The growing complexity of climate change within the global economy motivates researchers to explore its impact on various economic dimensions. In this quest, the present study explores the influence of climate risk index (CRI) and climate policy uncertainty (CPU) on the banking stability of the BRICS economies. In addition, the study also explores the moderating role of banking regulation and supervision on the aforementioned relationship. In order to accomplish the above objectives, the study employs a robust set of econometric models on the alternative proxies of banking stability, that is, Z-score and nonperforming loans (NPLs). Furthermore, to assess the impact of the Paris Agreement on the previously discussed relationship, the study analyses the above relationship across three distinct timeframes, that is, the complete sample (2007–2021), the period preceding the Paris Accord (2007–2014) and the timeframe following the Paris Accord (2015–2021). The findings from the panel-corrected standard error (PCSE) estimate indicate that CRI and CPU exert a negative impact on the banking stability by increasing the proportion of NPLs and reducing the Z-scores. In terms of the interaction variables, the study demonstrates that when CRI interacts with CPU, it exacerbates the negative influence on the banking sector’s stability. Moreover, considering the moderating variables, the empirical analysis indicates that banking regulation and supervision moderate the negative impact of CRI on the banking stability. The study also explains that the repercussions of the climate risk on the banking stability are more pronounced following the post-Paris Accord period compared to the period preceding the Paris Accord. The estimates remain consistent across various alternative methodologies, that is, the system-generalized method of moments and the fixed effects model. The study offers useful insight to comprehend the impact of climate risk on the banking stability.