Economic losses from natural disasters have been rising in recent decades and are expected to escalate in the future. A new study by the Institute for Environmental Studies (IVM) at VU Amsterdam reviews a large body of literature to gain a better understanding of the broader impacts of climate-related disasters on the financial system. The study, performed by Fujin Zhou, Thijs Endendijk and Wouter Botzen is published in Annual Review of Resource Economics and finds impacts on banking, insurance, stock markets, bond markets and international financial flows.
The financial sector is a cornerstone of our modern economy, and it plays a central role in addressing the evolving risks arising from climate change. Financial institutions have the power to invest in projects that encourage adaptation to disasters, share risks related to climate change, and provide financial support for recovery and reconstruction following climate-related disasters such as hurricanes, droughts, or floods. Conversely, climate change risks can disrupt financial stability and hinder economic growth. For this reason, it is essential to understand how disasters affect the financial sector.
From the extensive literature review, it becomes clear that climate change and natural disasters put substantial stress on the financial sector. They diminish the profitability of insurance companies, disrupt risk-sharing mechanisms, influence the stability of banks and the availability of credit, and affect the performance of stock and bond markets. These challenges underscore the need for a deeper understanding, proactive risk management, and the development of adaptation strategies within the financial sector to mitigate these adverse impacts.
The study has also identified several factors that can help mitigate the adverse impacts of extreme events. Elements such as trade openness, high-quality infrastructure, and various adaptation strategies contribute to building financial resilience in the face of a changing climate. Moreover, countries with higher incomes tend to possess a better financial buffer to absorb disaster-related losses. Conversely, low-income countries typically witness an increase in the inflow of international aid and remittances, providing vital financial support during challenging times.
The researchers stress the importance of computational modelling approaches for understanding the impacts of extreme climate events. It is crucial to focus on forward-looking research to better understand and prepare for the financial consequences of climate change. This is especially vital due to the central role of the financial sector in modern society and the increasing risks and uncertainties linked to a changing climate. The financial sector can play a pivotal role in promoting both climate adaptation and mitigation.
Source image: International Monetary Fund (IMF)
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