Climate Change Damages to Agricultural Loan Recoveries and Financial Stability: A Fresh Insight from a Developing Country

Abstract

This study investigates the impact of expected loan recoveries on the financial stability of Pakistani banks that are providing agricultural loans. The study explores short and long-run relationship, as well as its consideration of control variables and the potential impact of climate change factors on agricultural loans that add original insights to the existing literature on the nexus of farmers’ loans and banks stability in Pakistan. This study assesses the impact of climate-induced losses to loan recoveries on the financial stability of Pakistani banks engaged in providing agricultural loans for the sample period from 2000 to 2021 in the presence of control variables such as non-performing loans, profitability, equity-to-liabilities ratio, and retained earnings-to-total assets ratio. It constructs a specially designed composite index to measure Climate Change based on long-term weather data and employ the ARDL (Auto-Regressive Distributed Lag) technique to estimate the short and long-run association of expected loan recoveries on the financial stability of Pakistani banks. This study finds that the recovery of agricultural credit from farmers has a negative impact on the financial stability of banks in the short run but a positive impact in the long run. This indicates that banks may be insuring agricultural credits against damage due to climate change factors such as heavy rains out of season and extreme temperatures. This study suggests the importance of strong collaborations with private-public partnerships to ensure the effective utilization of agricultural loans on the micro-level to avoid financial instability.