Bank of Lithuania
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No 32

Climate Risk and Bank Capital Structure

  • Abstract

    We study the role of climate risk exposure in the dynamic behavior of banks’ regulatory capital adjustment using a large European sample from 39 countries during the 2006–2021 period. We find that banks facing high exposure to climate risk opt for a higher target (regulatory) capital adequacy ratio and make faster adjustments to their optimal capital structure, especially if they are more exposed to carbon pollution. Such banks boost their adjustment during the post-Paris Agreement period. These banks move to their target capital adequacy ratio mainly by adjusting their risk-weighted assets or by reallocating them more quickly than their peers, without necessarily altering assets, particularly lending. This paper lends support to the importance of taking climate change-related risks into prudential supervision to protect the financial system’s resilience and contributes to the debate on climate-related capital requirements.

    Keywords: Dynamic capital structure, Speed of adjustment, Climate change, Paris Agreement, Balance sheet composition.

    JEL Classification: G21, G28, Q53, Q54.

    The views expressed are those of the author(s) and do not necessarily represent those of the Bank of Lithuania.