DO CLIMATE RISKS CONTRIBUTE TO FINANCIAL SYSTEM STRESS? THE CASE OF ASEAN-5 COUNTRIES

• Main Author: Izzuddin, Anas
• Format: Theses
• Language: Indonesia
• Online Access: https://digilib.itb.ac.id/gdl/view/75371
• Institution: Institut Teknologi Bandung

We analyze the impact of climate change on financial system stress in ASEAN-5 countries: Indonesia, Malaysia, the Philippines, Singapore, and Thailand. Our study is the first comprehensive analysis that examines the role of climate change risk on financial system stress in these countries. We construct a financial stress index (FSI) using various financial indicators and measure physical climate risks using seven indicators grouped into weather-related, disaster-related, and composite proxies. We analyze the relationships between the FSI and its components with the physical risk variables by employing the first-difference Generalized Methods of Moments. Our constructed quarterly FSIs accurately reflect significant historical financial stress events. We observe a consistent pattern of increasing mean temperatures across all ASEAN-5 countries over time, while mean precipitation levels display the opposite trend. The Philippines and Indonesia have the highest occurrence of disasters, with the former experiencing the most climate-related disaster fatalities and affected populations. On the other hand, Thailand has recorded the most significant damage from disaster events. Our empirical baseline regression models reveal significant positive relationships between disaster-related variables and our constructed FSI, except for the number of disasters. Specifically, we find statistically significant positive coefficients for the total number of affected populations, fatalities, and total damages. Weather- related variables, such as mean precipitation and temperature, do not exhibit statistically significant relationships with the FSI. We argue that climate change contributes to financial system stress when it increases the frequency of extreme climate events. While gradually changing variables alone may not directly predict financial stress, they serve as precursors or contributing factors to climate-related disasters, contributing to financial system stress. In our extended regression models, interbank lending rates stand out as the dependent variable with the most significant associations with the physical risk variables. Specifically, we find positive coefficients of temperature mean, number of disasters, total affected populations, and total damages on interbank lending rates. Except for the net change in property index, other FSI components also demonstrate estimation results with statistically significant coefficients of the climate risk variables: three variables on the EMPI and two variables each on equity market change and sovereign bond spread. Our study emphasizes the critical need to recognize the broader implications of climate change on the occurrence and severity of extreme events and their impact on financial system stress. We highlight the importance of addressing climate change at its core to mitigate climate-related disasters and prevent the financial system from experiencing unhealthy stress levels. Our findings underscore the significance of policies enhancing physical resilience to cope with potential climate impacts. Furthermore, we emphasize the importance of macroprudential policies in safeguarding the financial system against stress from climate risks. We assert that macroprudential and high-level policies should actively ensure the banking sector's resilience from climate change's impact, as it plays a significant role in transmitting climate change risks to financial system stress. Additionally, these policies should address several other potential transmission channels of climate risk on financial system stress, such as the potential capital flights associated with extreme climate events and the differing impacts of climate change on different economic sectors, which may affect economic growth trajectory.