The impact of climate change risk on financial sector stability in selected EMEA countries

Abstract

The study examines the impacts of climate change risk on financial sector stability in selected European, Middle Eastern, and African countries. Specifically, the study aimed to examine the short- and long-term effects of climate change risk on the stability of financial markets and institutions. Furthermore, the paper compared the impacts of climate change risk on financial sector stability across the three regions, namely Africa, Europe, and the Middle East. Panel annual data for the period from 1990 to 2023, collected from 55 countries, were collected and analysed using the Pooled-Mean-Group-Autoregressive-Distributed-Lag (PMG-ARDL) estimator. The study revealed insignificant impacts of climate change risk on financial markets' stability both in the short and long term, whilst for financial institutions' stability, significant positive long-term effects and insignificant short-term impacts were found. The comparative analysis also revealed significant long-term negative and positive impacts of climate change risk in Africa and the Middle East, respectively. For Europe, climate change risk was found to have insignificant impacts in both the short and long term. The results led to the conclusion that the impacts of climate change risk on financial sector stability are heterogeneous across the three regions and financial sector stability dimensions. The results underscore the necessity for forward-looking, adaptive financial regulation that incorporates scenario analysis, climate stress testing, and dynamic climate-change risk modelling.