Climate Change and Sustainable Financial Stability: A Sector-Level Study for the Banking Sector in the European Union

This study investigates the relationship between climate change and financial risk by examining how temperature variations affect banking sector credit quality across European Union countries. Using quarterly panel data and sector-level non-performing loan (NPL) ratios from the EBA Risk Dashboard, the paper applies fixed-effects and dynamic panel models to estimate climate–credit sensitivities. Specifically, we investigate whether observed temperature changes affect sectoral NPLs in Europe and whether these effects differ across sectors. The results indicate a statistically significant and positive relationship between temperature changes and NPL levels, with notable heterogeneity across sectors. Evidence further suggests that climate shocks exhibit delayed effects on credit risk, as models incorporating lag structures yield stronger and more robust results. These findings provide empirical support for integrating climate variables into credit risk assessment and contribute to the literature by offering a sector-resolved, data-driven foundation for climate risk stress-testing frameworks.