From Climate Disasters to Systemic Risk: The Role of Syndicated Lending

Climate change is not just a hypothetical threat—it is now a global crisis with immediate consequences. According to the World Economic Forum (2), climate action failure, extreme weather events such as wildfires and hurricanes, and environmental damage arising from human activities rank among the most probable and severe risks facing the world over the next decade .

While much attention has been devoted to the economic consequences of climate change, a major challenge facing both climate finance researchers and practitioners is the shortage of methodologies that facilitate robust measurement of climate risk and promote a successful assessment of the impact of climate change on financial stability (3, 4).

Our recent study investigates how climate shocks transmit through the financial system (1). We find that syndicated lending (5) acts as a key transmission channel, exposing banks to climate risks in ways that amplify both individual and systemic financial instability.

Measuring Climate Risk at the State and Bank Levels

To quantify climate risk exposure, we link climate-related disaster data with syndicated lending records to measure how banks acquire climate risk through their loan portfolios. In this effort, we develop two sets of climate risk measures at the state and bank levels.

At the state level, we construct a state-level climate risk index using data from NOAA’s Billion-Dollar Weather and Climate Disasters database. This index incorporates key indicators such as financial losses, fatalities, and the frequency of extreme weather events.

At the bank level, we calculate bank-level climate risk exposure by assessing the proportion of a bank’s syndicated loans allocated to firms in high-risk states. We distinguish between cross-state lending, which captures risk from lending to firms in other states, and home-state lending, which measures exposure from loans within a bank’s home state. Our emphasis on cross-state lending highlights how climate shocks propagate through financial networks rather than remaining confined to local economies.

Syndicated Lending as a Transmission Channel for Climate Shocks

Extreme and unexpected climate events do not only harm the immediate victims but also create ripple effects that threaten the financial system as a whole. When banks provide syndicated loans to firms operating in disaster-prone areas, they expose themselves to climate shocks that can significantly increase their risk exposure.

If borrower firms suffer financial distress due to a climate-related disaster, their ability to repay loans diminishes, and this effect is transmitted through the network of banks that participated in the syndicated loan. If multiple borrowers in affected regions default simultaneously, the resulting financial instability can spread beyond individual institutions and escalate into a broader economic crisis.

By focusing on syndicated lending, we provide evidence that banks are not only exposed to climate risk through their immediate locations but also through the geographic footprint of their lending portfolios. 

Our results indicate a strong relationship between syndicated lending exposure to climate shocks and increased financial risk. When climate risk exposure through syndicated lending increases by one standard deviation, banks’ financial risk indicators deteriorate across the board. Marginal expected shortfall, which measures the average loss a bank can expect in extreme scenarios, rises by 14.7% in the short term and 1.3% in the long term. Similarly, value-at-risk, which captures the maximum probable loss a bank could incur, increases significantly.

The study also finds that systemic risk contribution—the extent to which a bank’s distress can destabilize the broader financial system—becomes more pronounced under heightened climate risk exposure. In other words, banks that participate in syndicated loans in climate-vulnerable regions are more susceptible to financial instability.

Banks’ Response: Reactive Rather Than Proactive

Beyond assessing the risks, our study also examines how banks respond to climate shocks. The findings reveal that banks tend to react in a defensive manner: after experiencing financial damage from climate disasters, they cut their lending activity and increase loan loss reserves. This pattern suggests that while banks recognize climate risk, they generally react only after suffering financial losses rather than proactively incorporating these risks into their decision-making processes.

Interestingly, not all banks are equally vulnerable. Some institutions demonstrate greater resilience, either due to their long-term financial management strategies or their ability to absorb financial shocks. Banks with stronger capital reserves tend to be less affected by climate shocks, as they have the financial capacity to cushion against unexpected losses. Similarly, banks with higher profitability levels appear to benefit from a natural buffer that helps them better withstand climate-related financial distress.

These findings highlight the importance of financial resilience in mitigating climate-related risks and suggest that banks should take a more forward-looking approach by integrating climate risk metrics into their risk management strategies.

Implications for Financial Regulation

The implications of our research extend beyond individual banks to broader regulatory oversight, highlighting that climate risks are building up on banks’ balance sheets while supervisory reviews show that banks are not well prepared—yet regulators have been slow to incorporate these risks into minimum capital requirements (6).

Our results stress the urgent need for climate stress testing in financial stability assessments, as current frameworks do not fully capture the cascading effects of climate shocks on financial markets. 

Regulators must integrate climate risk into their macroprudential oversight to prevent potential crises, while banks should adjust risk pricing by incorporating climate risk exposure into loan assessment models. Many financial institutions only account for climate risk post-loss, rather than proactively, underscoring the need for pricing strategies that strengthen resilience and prevent capital shortfalls. 

Moreover, financial stability hinges on robust capital buffers and profitability, especially for banks with significant exposure to climate-vulnerable regions, enabling them to better absorb climate-related shocks.

A Call to Action

The key takeaway from our research is that climate change is not just an environmental issue; it is a financial threat that requires immediate action. Banks, regulators, and policymakers must integrate climate risk measures into financial decision-making to ensure long-term financial stability.

The findings reinforce the importance of a proactive approach—one that prioritizes robust climate risk assessment, regulatory oversight, and stronger financial buffers. Climate-related financial instability is not an abstract risk of the future—it is already happening, and the financial sector must act now to mitigate its consequences.

References

1. Conlon, T., Ding, R., Huan, X., & Zhang, Z. (2024). Climate risk and financial stability: evidence from syndicated lending. European Journal of Finance, 30(17), 2001-2031. https://doi.org/10.1080/1351847X.2024.2343111

2. World Economic Forum (2025). The Global Risks Report 2025. https://reports.weforum.org/docs/WEF_Global_Risks_Report_2025.pdf

3. Bank for International Settlements. (2022). The regulatory response to climate risks: Some challenges. https://www.bis.org/fsi/fsibriefs16.pdf

4. Battiston, S., Dafermos, Y., & Monasterolo, I. (2021). Climate risks and financial stability. Journal of Financial Stability, 54, 100867. https://doi.org/10.1016/j.jfs.2021.100867

5. A syndicated loan is offered by a group of lenders who work together to provide credit to a large borrower. The borrower can be a corporation, an individual project, or a government. Each lender in the syndicate contributes part of the loan amount, and they all share in the lending risk. https://corporatefinanceinstitute.com/resources/commercial-lending/syndicated-loan/

6. Van Tilburg, R., Grünewald, S., Schoenmaker, D., & Boot, A. (2022). Climate risks are real and need to become part of bank capital regulation. VoxEU. https://cepr.org/voxeu/columns/climate-risks-are-real-and-need-become-part-bank-capital-regulation