Climate-related and environmental risks for the banking sector in Latin America and the Caribbean: a preliminary assessment

This paper attempts a preliminary estimation of LAC commercial banks’ credit risk resulting from climate-related and environmental physical risks and transition risks. This is relevant for at least three reasons. First, the LAC region is the second most disaster-prone region globally, where natural disasters have become more frequent and destructive. Across different climate-related natural disasters, floods and storms have recently increased their frequency and impact in LAC. Second, temperatures are projected to increase to a significant degree in the coming decades, negatively impacting economic activity and the financial sector. An increase in temperature is associated with lower growth, with contractionary effects felt several years after a weather-related shock. Finally, although capital markets are developing in several emerging markets in LAC, the banking sector remains central to financial intermediation in the region.

The results also show that banks in the region are exposed to transition risks, especially in Argentina, Bolivia, Paraguay, and Uruguay, due to their high lending to the agriculture sector, which is the largest emitter of greenhouse gases in the countries. Firms operating in transition-sensitive sectors already present signs of financial stress, especially those in the fossil fuel and agriculture sectors. Overall, the results demonstrate the importance for financial authorities in the region to advance in the integration of climate-related and environmental risks in their work.