Climate risk and financial stability: some panel evidence for the European banking sector

Guglielmo Maria Caporale, Anamaria Diana Sova and Robert Aurelian Sova

Chapter 6 in Handbook of Climate Change and Financial Markets, 2026, pp 95-109 from Edward Elgar Publishing

Abstract: This chapter provides new panel evidence on the effects of climate risk on financial stability in the European banking sector using yearly data over the period 2000–2021. More specifically, the impact of a number of climate risk indices on the Z-score (capturing the probability of default of a country's banking system) is assessed after controlling for various macro and bank-related factors. The estimation is carried out using the Generalised Method of Moments. The analysis is also performed for two subsets of countries, namely EU (European Union) and non-EU countries. Finally, the role of governance quality is investigated. The results suggest that higher emissions growth tends to be associated with lower Z-scores, which indicate lower financial stability. However, the size of this effect differs between EU and non-EU European countries, suggesting that differences in policies, regulatory environments, and economic structures may influence how emissions growth affects financial stability across these areas. Our analysis also shows that the climate risk–financial stability relationship is affected by the quality of governance since the World Governance Index does not appear to have a mitigating effect in non-EU countries with poorer governance.

Keywords: Climate risk; Financial stability; Z-score; Europe; Panel data; GMM (Generalised Method of Moments); Estimator (search for similar items in EconPapers)
Date: 2026
ISBN: 9781035340415
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