The impact of natural disaster risk on the banking sector

Natural disasters bring about considerable destruction, with potentially rising future risk brought about by climate change. While immediate and unconstrained access to finance is necessary for recovery following a natural disaster, such shocks can lead to credit market breakdowns, which may hinder an economy from regaining growth or deepen and prolong existing recessions and push countries into poverty. There is however, a paucity of evidence on natural disasters and finance. We construct a panel of quarterly banking data, and histor-ical losses due to hurricanes for the Eastern Caribbean to econometrically investigate their impact on the banking industry. Our results suggest that commercial banks experience nega-tive shocks to both assets and liabilities following a hurricane. The fall in deposits and other liabilities is possibly related to withdrawals for financing clean-up and recovery as well as the inability of banks to rollover short-term debt. Banks respond to the negative funding shock by reducing lending and other investments. The credit contraction is explained by a combina-tion of reductions in bank lending to households, lending to non-residents, and interbank lending. The results therefore suggest that the withdrawal and use of deposits rather than an expansion in credit appears to play a significant role to fund post hurricane recovery in the region. This points to the importance of an active reserve requirements policy on deposits which could be heightened during hurricane seasons and lowered in response to hurricane strikes and during normal times. More specifically, central banks could increase reserve re-quirements during hurricane seasons and lower them during normal times or in response to hurricane strikes. This is especially important given the possible increase in the frequency and intensity of hurricanes related to climate change, since bank stability and performance may be even more negatively affected in the future.