However, when combined with an economic downturn, the drought caused a 40% increase in dairy loan defaults over four years, before returning to levels similar to today. This result illustrates the importance of nonlinearities in the financial impacts of climate change. Internationally, our central banking peers have also recognised the need to better understand the financial stability risks posed by climate change.
In May this year, the Bank of England (BoE) published the results of its inaugural scenario analysis. Banks and insurers’ projections showed that “climate risks could cause a persistent and material drag on their profitability”, IF they “do not respond effectively” to physical and transition risks6.