Evaluation of Climate Change Factors & Their Impact on Credit Risk Management in the Banking Sector of Pakistan
DOI:
https://doi.org/10.54938/ijemdss.2026.05.2.672Keywords:
: Climate Change, Environmental Social & Governance (ESG), Credit Risk Management, Sustainable Development Goal 13 (SDG 13), Panel ARDL, Pakistan Banking SectorAbstract
This paper evaluates climate change factors and their impact on credit risk management in the banking sector of Pakistan. The dataset consists of variables leading to a destabilized climate and banking indicators of 32 commercial banks operating in Pakistan between 2015 and 2024. The panel data of four cross-sectional bank categories; five public sector commercial banks, 20 local private banks, four foreign banks, and three specialized banks were collected from the State Bank of Pakistan, while climatic indicator figures were extracted from the Climate Change Knowledge Portal of the World Bank and the Food and Agriculture Organization (FAO) of the United Nations data. This study is based on two empirical models. In Model-1, the dependent variable is non-performing loans, and the climate change indicators temperature anomalies, precipitation patterns, sea level rise, flood frequency, and emissions are independent variables used to quantify climate-driven credit risk. Secondly, Model-2 measures banking profitability in terms of return on assets (ROA) and return on equity (ROE) as dependent variables, in relation to loan loss provisioning, liquidity ratios, and weighted average capital adequacy ratios as the independent variables. The panel Autoregressive Distributed Lag (ARDL) approach was applied to both models in EViews 13. This method affirms cointegration in selected types of banks, with cross-sectional heterogeneity revealing that local private banks (N=20) and specialized banks (N=3) are significantly more exposed to long-run climate-induced credit risk compared to foreign and public sector commercial banks. These findings uncover variations among cross-sections, revealing structural fragilities in the banking sector, thereby emphasizing the critical need for climate-sensitive credit frameworks. The study highlights the importance of integrating advanced environmental, social, and governance (ESG) risk strategies and climate stress testing into Pakistan’s banking risk management framework to enhance resilience against climate-related financial vulnerabilities. This research directly aligns with the United Nations 2030 Agenda for Sustainable Development, specifically Sustainable Development Goal 13 (SDG 13: Climate Action).
Downloads
References
Addoum, J. M., Ng, D. T., & Ortiz-Bobea, A. (2020). Temperature shocks and establishment sales. The Review of Financial Studies, 33(3), 1331–1366. doi.org
Ahmad, S., Khan, M. A., & Rahman, N. u. (2020). Green banking adoption and its impact on financial performance: Evidence from commercial banks in Pakistan. Journal of Business and Tourism, 6(1), 115–128.
Ahmed, Z., Asghar, M. M., Malik, M. N., & Nawaz, K. (2021). Moving towards a sustainable environment: The dynamic nexus between natural disasters, institutional quality, and financial development in Pakistan. Environmental Science and Pollution Research, 28(32), 43915–43928. doi.org
Athanasoglou, P. P., Brissimis, S. N., & Delis, M. D. (2008). Bank-specific, industry-specific and macroeconomic determinants of bank profitability. Journal of International Financial Markets, Institutions and Money, 18(2), 121–136. doi.org
Battiston, S., Mandel, A., Monasterolo, I., Schütze, F., & Visentin, G. (2017). A climate stress-test of the financial system. Nature Climate Change, 7(4), 283–288. doi.org
Baulch, B., & Saleem, S. (2022). The macroeconomic impacts of extreme weather events in South Asia: A comprehensive regional analysis. South Asian Journal of Macroeconomics and Public Finance, 11(2), 145–172.
Beck, R., Jakubik, P., & Piloiu, A. (2013). Non-performing loans: What matters in addition to the macroeconomy? European Central Bank Working Paper Series, No. 1515.
Berger, A. N., & Bouwman, C. H. (2009). Bank liquidity creation. The Review of Financial Studies, 22(9), 3779–3837. doi.org
Blackburne, E. F., & Frank, M. W. (2007). Estimation of nonstationary heterogeneous panels. The Stata Journal, 7(2), 197–208. doi.org
Brei, M., Mohan, P., & Strobl, E. (2019). The impact of natural disasters on the banking sector: Evidence from hurricane strikes in the Caribbean. Journal of International Money and Finance, 92, 130–144. doi.org
Bushman, R. M., & Williams, C. D. (2012). Forward-looking provision for loan losses and the systemic risk of banking systems. Journal of Accounting and Economics, 54(2-3), 210–232. doi.org
Campiglio, E., Dafermos, Y., Monnin, P., Ryan-Collins, J., Schanz, G., & Tortusa-Martinez, F. (2021). Climate change challenges for central banking and financial regulation. Nature Climate Change, 8(6), 462–468.
Capasso, G., Gianfrate, G., & Spinelli, M. (2020). Climate change and credit risk. Journal of Cleaner Production, 266, Article 121634. doi.org
Chen, X., Zhao, X., & Chang, C.-P. (2023). The impact of natural disasters on bank credit risk: Economic evidence from 101 countries. Natural Hazards, 115(1), 693–717. doi.org
Dafermos, Y., & Nikolaidi, M. (2021). How can green differentiated reserve requirements affect climate-related financial risks? Journal of Financial Stability, 54, Article 100871. doi.org
Dietrich, A., & Wanzenried, G. (2014). The determinants of commercial bank profitability before and during the financial crisis: Evidence from Switzerland. Journal of International Financial Markets, Institutions and Money, 21(3), 307–327.
Fair Finance Thailand. (2025). Implementing TCFD recommendations in emerging Asian banking frameworks: A path to transparency. Fair Finance Guide International.
Fan, Q., & Gao, W. (2024). Climate risk and financial stability: The mediating effect of green credit. Finance Research Letters, 65, Article 105558. doi.org
Ghesquiere, F., & Mahul, O. (2010). Sovereign natural disaster insurance for developing countries: A framework for catastrophe risk financing and options for World Bank support. World Bank Policy Research Working Paper, No. 5430. World Bank.
Government of Pakistan. (2023). Pakistan economic survey 2022-23. Ministry of Finance. finance.gov.pk
Intergovernmental Panel on Climate Change. (2021). Climate change 2021: The physical science basis. Cambridge University Press.
International Finance Corporation. (2021). Climate risk assessment and financial adaptation mechanisms across South Asian economies. World Bank Group.
International Monetary Fund. (2021). Global financial stability report: Climate change: Physical risks and equity prices. IMF.
Khan, M. R., & Ullah, K. (2022). Effectiveness of green project screening for bank lending: Evidence from Pakistan. Bulletin of Business and Economics (BBE), 11(1), 93–103.
Klomp, J. (2014). Financial fragility and natural disasters: An empirical analysis. Journal of Financial Stability, 13, 180–192. doi.org
Klomp, J. (2019). Do natural disasters affect bank performance? International Journal of Finance & Economics, 24(4), 1662–1678. doi.org
Loayza, N., & Rancière, R. (2006). Financial development, financial fragility, and growth. Journal of Money, Credit and Banking, 38(4), 1051–1076. doi.org
Louzis, D. P., Vouldis, A. T., & Metaxas, V. L. (2012). Macroeconomic and bank-specific determinants of non-performing loans in Greece: A comparative study of a common euro area member state. Journal of Banking & Finance, 36(4), 1012–1027. doi.org
Melecky, M., & Raddatz, C. (2011). How do governments respond to natural disasters? Asymmetric responses and the role of fiscal reserves and financial insurance. World Bank Policy Research Working Paper, No. 5564. World Bank.
Mirza, N., Umar, M., & Afzal, A. (2024). Greenhouse gas emissions and the degradation of bank credit quality in developing Asian economies. Environmental Science and Policy, 151, 103–112.
Mukhtar Adam, M., Hassan, S., & Shuaibu, M. (2023). Enterprise risk management and structural resilience against environmental shocks: A panel data evidence from banking networks. Journal of Risk and Financial Management, 16(4), 211.
Musyoki, D., & Kadubo, A. S. (2012). The impact of credit risk management on the financial performance of commercial banks in Kenya. International Journal of Business and Public Management, 2(2), 72–80.
Naili, M., & Lahrichi, Y. (2022). The determinants of non-performing loans in the banking sector: A systematic literature review. Journal of Financial Regulation and Compliance, 30(4), 450–475. doi.org
National Disaster Management Authority. (2022). Pakistan floods 2022: Post-disaster needs assessment report. Government of Pakistan.
Ng, D. T., Ortiz-Bobea, A., & Zhang, H. (2020). Temperature exposures, establishment sales, and corporate productivity. Journal of Financial Economics, 138(2), 542–566.
Ng, T. H., & Tao, J. Y. (2016). Bond market consequences of long-term environmental degradation: A global perspective. Journal of Banking & Finance, 71, 114–129.
Nguyen, P. H., Kim, J., & Choi, S. (2023). Decarbonization regulatory pressures and asset transition risks in global commercial banks. Journal of Financial Stability, 67, Article 101142.
Nkusu, M. (2011). Nonperforming loans and macrofinancial vulnerabilities in advanced economies. International Monetary Fund Working Papers, No. 11/161.
Noy, I. (2009). The macroeconomic consequences of natural disasters. Journal of Development Economics, 88(2), 221–231. doi.org
Ortiz-Bobea, A., Ault, T. R., Carrillo, C. M., Chambers, R. G., & Lobell, D. B. (2021). Anthropogenic climate change has slowed global agricultural productivity growth. Nature Climate Change, 11(4), 306–312.
Pesaran, M. H., Shin, Y., & Smith, R. P. (1999). Pooled Mean Group estimation of dynamic heterogeneous panels. Journal of the American Statistical Association, 94(446), 621–634. doi.org
Qadir, G., Iftikhar, K., & ul Mustafa, A. R. (2025). Dynamics Of Credit, Liquidity and Solvency Risk: A Multidimensional Panel Approach in Case of Pakistan’s Banking Sector. IUB Journal of Social Sciences, 7(2), 98-115.
Rahat, B., Lucey, B. M., & Yarovaya, L. (2023). Green transmission channels: How transition risks reshape bank credit portfolios. British Accounting Review, 55(2), Article 101115.
Rehbein, O., & Ongena, S. (2020). Flooded with liquidity? Mass withdrawals and unexpected emergency credit demand after environmental shocks. ZEW Discussion Paper, No. 20-043.
Roncoroni, A., Battiston, S., D’Orazio, G., & Monasterolo, I. (2021). Climate risk and financial stability in the eurozone: A transition risk stress test. Journal of Banking & Finance, 127, Article 106057. doi.org
Sarfraz, M., Shah, S. G. M., & Ivascu, L. (2022). The trade-off between green financial lending and short-term banking returns in emerging South Asian markets. Sustainability, 14(9), 5281.
Schuwer, U., Fischer, F., & Noth, F. (2019). How do banks react to catastrophic natural disasters? Bank capital adequacy and risk-taking behavior. Journal of Financial Intermediation, 38, 26–41. doi.org
Shoaib, M., Ullah, K., & Ali, S. (2024). ESG practices, risk infrastructure transparency, and bank financial performance in emerging economies. Journal of Cleaner Production, 434, Article 139850.
Siddiqui, A., & Rehman, H. (2025). Climate change damages to agricultural loan recoveries and the financial stability of Pakistani banks. Pakistan Social Sciences Review, 9(1), 714–726.
Smith, K. (2003). Environmental hazards: Assessing risk and reducing disaster. Routledge.
State Bank of Pakistan. (2022). Financial stability review 2021. SBP Printing Press. sbp.org.pk
State Bank of Pakistan. (2023a). Environmental and social risk management (ESRM) manual for banks and DFIs. State Bank of Pakistan / Sustainable Banking Network (SBFN). sbp.org.pk
State Bank of Pakistan. (2023b). State Bank of Pakistan annual report 2022-23. SBP Printing Press. sbp.org.pk
State Bank of Pakistan. (2024). Financial stability review 2023. SBP Printing Press. sbp.org.pk
Surminski, S., & Oramas-Dorta, D. (2017). Flood insurance penetration and financial post-disaster vulnerabilities in developing economies. Climate and Development, 9(4), 352–366. doi.org
Tan, Y., Floros, C., & Anchor, J. (2019). The impact of capital adequacy on bank profitability, efficiency, and risk-taking. International Journal of Finance & Economics, 24(3), 1215–1232. doi.org
Ul Mustafa, A. R., Ansari, R. H., & Younis, M. U. (2012). Does the loan loss provision affect the banking profitability in case of Pakistan?. Asian Economic and Financial Review, 2(7), 772.
Wang, F., Zhao, L., & Zhou, D. (2024). Industrialization, fossil fuel consumption, and the acceleration of structural climate risk vectors. Journal of Environmental Management, 352, Article 119910. doi.org
Zhao, X., Chen, X., & Chang, C.-P. (2024). Severe monsoonal precipitation variability, glacier melts, and credit defaults in South Asia. Natural Hazards, 121(2), 1435–1458. doi.org
Downloads
Published
How to Cite
Issue
Section
License
Copyright (c) 2026 Shumaila Khan, Hina Fatima, Afaq Ali Khan
This work is licensed under a Creative Commons Attribution 4.0 International License.
Under the Creative Common Attribution (CC-BY 4.0) license, authors retain copyright and grant the journal right of first publication.
