Climate risk and financial stability: A systemic risk perspective from Thailand

The systemic implications of climate risks for financial stability remain underexplored in emerging market and developing economies, despite their heightened exposure to climate shocks. This study examines how transition and physical climate risks affect banking systemic risk in Thailand. Using a market-based measure of systemic risk derived from conditional value-at-risk (CoVaR), we find that transition risk—captured by a Brown-minus-Green factor—significantly amplifies systemic vulnerability in the Thai banking sector. Physical climate risk also matters, with extreme wet conditions such as floods increasing systemic risk, while the effects of drought are limited over the sample period. Mediation analysis reveals distinct transmission mechanisms: transition risk operates primarily through the credit channel by increasing non-performing loans, whereas physical climate risk affects systemic risk mainly through asset price volatility, with a delayed impact. The effects of climate risk are stronger for large, systemically important banks and for banks with greater exposure to climate-sensitive sectors. These findings underscore the importance of incorporating both transition and physical climate risks—and their distinct transmission channels—into prudential supervision and climate stress testing frameworks, particularly in emerging market contexts.