European Central Bank publishes working paper finding floods temporarily raise lending but increase default rates by about 0.7 percentage points

The European Central Bank has published a Working Paper by ECB authors on how physical climate risk affects bank lending and credit quality after major floods in Europe. Using Copernicus flood maps matched with AnaCredit loan-level data for four flood events between 2021 and 2024, the paper finds that lending to affected firms rises by about 3.5% to 5% in the quarter of the flood, then contracts by a similar amount in the following quarter, while default rates on pre-existing loans increase persistently by around 0.7 percentage points over two quarters. The paper states that these views are those of the authors and do not necessarily reflect those of the ECB. The analysis compares firms located just inside and just outside flood boundaries, typically within 300 to 500 metres, to isolate the effect of flood exposure. Interest rates show a similar short-term pattern to lending volumes, rising modestly in the first quarter and partially reversing in the second, with no statistically significant cumulative effect over two quarters. The paper finds that demand factors dominate the credit response, as banks with greater exposure to affected firms do not systematically cut lending, raise rates or tighten terms more than other lenders. Relationship banks do provide roughly 10 percentage points more credit to affected firms, but also require more collateral. Immediate effects vary mainly by sector and pre-existing firm risk, with wholesale and retail, construction and services firms seeing stronger short-term lending responses than manufacturing firms, while banks expand credit to lower-risk affected firms and curtail it for higher-risk ones.