Breaking the bank: Climate change and the next financial crisis

Breaking the bank: Climate change and the next financial crisis

Climate change will fundamentally reshape our economy, leaving almost no industry untouched. New research suggests that climate change may impact the stability of the banking sector, potentially leading to financial crises and increased public debt.

Lamperti, F., Bosetti, V., Roventini, A. et al. The public costs of climate-induced financial instability. Nat. Clim. Chang. 9, 829–833 (2019).

During the 2008 financial crisis, homeowners’ inability to repay their loans brought banks to the brink of collapse. The U.S. government was forced to bail out financial institutions that were “too big to fail” with $21 billion in taxpayer funds. Although the U.S. and global economies have recovered substantially since then, another financial crisis may be looming.

To better understand the risk of financial crisis, a 2019 Nature Climate Change study attempted to determine if climate change will make banking crises, and the subsequent bailouts, more frequent. The researchers examined how climate change could threaten the global economy in several important ways. As climate change makes extreme weather events more frequent and severe, businesses will incur additional costs in repairs, retrofits, and insurance coverage. Additionally, the researchers demonstrate that increased temperatures can drive down productivity by negatively impacting worker’s cognitive and operational abilities. As industries suffer, they may default on their loans, potentially setting the stage for another financial crisis.

The study modelled the economic risk of climate change in two ways. First, it considered how climate change affects productivity. Second, it considered the physical risk to capital and infrastructure from heat, storms, and other effects of climate change. Based on these two metrics, the study found that climate change will increase the frequency of banking crises by as much as 248 percent. The researchers also found that the number of bailouts in response to these crises will increase substantially.

Climate change could make financial crises more than twice as likely to occur. Rescuing failing banks could cost governments from 5 to 15 percent of their gross domestic product and significantly increase public debt. This debt has long-term consequences for governments and the public they serve.

The study’s focus on bailouts is a novel way to quantify an underappreciated public cost of climate change. When governments bail out financial institutions, the costs of those bailouts are passed on to taxpayers. If bank failures become more common because of climate change, it is important to understand how the financial burden of bailouts might be passed on to the public.

These findings are particularly important as governments and businesses prepare for a new climate future. Failure to include the financial sector in climate change studies could leave the global economy vulnerable to another crisis, but policy interventions could play an important role in preventing a climate-induced economic downturn. 

Although several warning signs preceded the 2008 Great Recession, they were largely ignored. With research like this, we may be able to divert the next financial crisis brought on by climate change.