Climate Related Risks and It’s Impacts on the Financial Health of Pakistani Banks: Moderating Role of Green Banking

Abstract

Climate change is a new source of financial risk exposure for the banking system, especially for those economies that are highly susceptible to climate change. This research explores the implications of financial risks posed by climate change on financial health of banks in Pakistan through the NPL ratio method. The study explores the importance of green banking practices while making the banking system more robust against financial risks posed by climate change. The research design is quantitative. The study examines panel data for 19 publicly listed commercial banks over 2015-2024.This analysis considers both physical risks associated with climate change, such as flood, drought, mass movements (wet or dry), air pollution, and extreme weather, and transition risks that may arise from changes in policies/factors that exert pressure on a low-carbon economy. This study also tests whether green banking operations through Environmental, Social, and Governance (ESG) factors helps ameliorate risks posed by climatic changes on banks’ asset quality. The empirical results indicate that both physical and transition climate risks significantly heighten banks' NPL ratios, indicating heightened credit risk because the climate-related shocks deteriorate borrowers' debt-repaying ability. However, the findings also show that in the presence of sound green banking practices, banks exhibit low sensitivity of NPLs to climate risks, thereby inferring crucial roles that a greener lending policy and reinforced risk management frameworks play in cushioning climate-induced credit deterioration. This study pinpoints how the strategic importance of embedding green banking at the heart of core banking operations is not only underway to enhance environmental sustainability but also to enhance credit risk management and assure financial stability. These findings provide actionable insights for bank management and policymakers seeking to develop climate-resilient banking strategies in emerging markets.