A recent report from the International Panel on Climate Change reveals a consistent rise in extreme heat days, affecting agriculture and beyond. Economic repercussions include reduced labour productivity and increased operational costs. Recent studies also emphasise climate's financial sector impact, especially in low- and middle-income economies. This column delves into Mexican financial vulnerabilities, revealing the link between extreme heat and increased delinquency rates, particularly among small and medium-sized enterprises. Policy must address these risks, coupling climate resilience with enhanced credit access for vulnerable firms.
Central banks and other financial institutions are increasingly concerned about the impact of these shocks on the financial sector (Reinders et al. 2023). The effect of unfavourable weather on costs and demand may create liquidity shortages for firms that could cause solvency problems. In developing countries, several conditions suggest that firms may be more vulnerable. Suppose, for instance, the defaults generated by the shock increase lenders’ uncertainty about borrowers’ ability to repay their loans in the future. In that case, they might charge higher interest rates for new loans and reduce credit availability, increasing firms’ credit constraints. This is especially relevant for credit types for which the ability to repay is more uncertain, such as new small and medium-sized enterprises (SMEs) with scarce credit history, or for firms needing investment loans, which have longer maturity and higher uncertainty about future profits that the investment would generate. Overall, the impact of independent and identically distributed shocks could be longer-lived when hitting credit markets that deal less efficiently with informational asymmetries such as those in low- and middle-income economies.
Moreover, it is important to note that warming is not projected to affect countries homogeneously. Most developing countries are in regions with higher baseline temperatures. Hence, even uniform warming could have disparate impacts due to hard biological limits for agricultural yield and human health. However, current models project significant heterogeneity in local warming, as shown in Figure 2. For all the reasons above, understanding the impacts of extreme weather events on the financial sector in developing countries is of high policy relevance.
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