From Extreme Events to Extreme Seasons: Financial Stability Risks of Climate Change in Mexico

IMF Working Papers, August 25, 2023

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Canonical URL: From Extreme Events to Extreme Seasons: Financial Stability Risks of Climate Change in Mexico

The paper explores the financial stability implications of acute physical climate change risks using a novel approach that focuses on a severe season associated with a sequence of tropical cyclone and flood events.
The approach was applied to study physical risks in the Mexican financial sector and is applicable to other countries.
Even if the scale of individual climate events may not be material at an aggregate national scale, a sequence of events could lead to potentially significant macro-financial impacts in the short term.
Significant impacts could occur even if none of the individual events affect the particular region(s) with highest concentrations of banking sector exposures.
Results indicate potential for even greater effects in the future given the increasing severity and frequency of extreme events from climate change.
The paper highlights the importance of considering sequences of extreme physical risk events driven by climate change, rather than just individual extreme events, to better understand financial stability implications and design effective policies.

Focus on sequences of tropical cyclone and flood events (an "extreme season") as drivers of acute physical risk.
Sequences of events can amplify macro-financial impacts compared with isolated events, even when individual events are not material at the national aggregate level.
Banking sector exposures concentrated in specific regions may still face significant losses if a season's sequence of events affects other regions and produces system-wide effects.
The severity and frequency of extreme events are projected to increase, implying potential for greater future financial stability risks.

Financial stability assessment frameworks should incorporate sequences of extreme physical risk events (extreme seasons) driven by climate change.
Stress testing and macro-financial analysis should move beyond single-event scenarios to capture clustering and sequencing of events.
Design of effective policies for resilience and contingency planning should account for short-term macro-financial impacts arising from multiple-event seasons.