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| The Impact of Environmental Disasters on the Bank Default Rate: Theoretical and Empirical Analysis |
| WANG Yao, WANG Wenwei
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International Institute of Green Finance & Institute for Finance and Economics, Central University of Finance and Economics;
School of Finance, Central University of Finance and Economics |
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Abstract China has experienced frequent environmental disasters with huge negative impacts on economic and social development. The real economy and financial sector are becoming more closely aligned, and the impact of environmental disasters on the real economy will inevitably be transmitted to the financial system and institutions, affecting financial stability, generating financial risks, and generally amplifying the negative impact of environmental disasters. From the perspective of physical risk, this paper discusses the actual impact of environmental disasters on banks' default risk through dynamic stochastic general equilibrium model simulations and empirical tests using data from China's banking institutions from 2008 to 2018.
This article's main contributions are as follows: First, it is one of the first theoretical and empirical studies on China's environmental risks. Second, in terms of research methods, this article simultaneously introduces disaster shock factors and the financial friction mechanism, highlighting the amplification effect of the financial accelerator mechanism on the impact of disaster shocks. Further, this article examines the impact of disaster shocks on relevant economic and financial indicators, including bank default rates. In terms of empirical research, this article uses the entropy method to construct environmental disaster loss indicators on multiple dimensions, providing empirical evidence from China of environmental risks. Third, the theoretical and empirical tests not only support the existence of environmental risks but also further analyze and explore a series of derivative consequences of environmental disasters on banks' default rates, including the impact on corporate financing constraints and banks' willingness to lend. This enriches the research perspectives on topics such as financing constraints and bank liquidity creation.
The simulation results of the theoretical model show that environmental disasters significantly increase the default rate of bank credit contracts. This leads to higher risk premiums and reduces the scale of credit issuance, undermining enterprises and increasing their financing costs. Eventually, the tightening of financing constraints significantly negatively affects investment and output, reducing enterprises' leverage. Consistent with these results, the empirical tests show that environmental disasters significantly increase banks' default rates, and these findings pass a series of robustness tests. The mechanism test shows that the decline in total factor productivity, asset impairment loss and the increase in macroeconomic uncertainty are all significant transmission channels in this process. Further analysis shows that the environmental disaster effect of increasing the default rate significantly reduces the risk appetite of banks, reducing the scale of lending and risk-taking. This then restricts enterprises through tighter financing constraints and higher financing premiums, negatively affecting their operations.
The main conclusions of this paper have the following policy implications: First, the systems and mechanisms to deal with environmental disasters should be improved and more attention given to the negative impacts of environmental disasters on the financial system. Next, awareness should be strengthened, and financial factors fully incorporated into the system. Second, government departments should consider the stability of the financial system when formulating disaster relief policies. Specifically, they should explore establishing disaster financial stability funds to prevent financial system runs and liquidity crises caused by extreme events. The supervision of financial institutions should include a standing disaster reserve, improving the construction of disaster recovery centers, adopting relevant incentives to guide financial institutions to reduce investment and credit for brown stranded assets, and encouraging financial institutions to engage in green finance. Third, the financial sector must fully consider climate and environmental risks and conduct environmental stress tests on a regular basis. Before launching a credit business, banks and other financial departments should thoroughly assess the climate and environmental risks of the business and region and fully consider environmental disaster risks in credit pricing. After a disaster occurs, the financial sector should also actively assist disaster-stricken enterprises through extensions and other benign interactions.
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Received: 28 June 2021
Published: 01 January 2022
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