Introduction & Context
U.S. flood risks have intensified with climate change, damaging over $150 billion in assets annually according to FEMA data, yet banks' responses to these risks in lending decisions remained understudied until now. This NBER paper addresses a critical gap: how physical climate events like floods influence credit allocation, potentially worsening economic downturns in affected regions. It builds on prior work showing insurers pulling back from high-risk areas, extending the lens to banking and firm financing. For American households and businesses in flood-prone zones—covering 12% of the population per Census data—this reveals hidden financial vulnerabilities tied to weather extremes.
Methodology & Approach
Researchers matched granular loan-level data from U.S. commercial banks with precise FEMA flood maps and a database of major flood events from 2001 to 2024, covering millions of loans. They applied a difference-in-differences framework, comparing lending changes to firms just inside high-risk flood zones versus similar firms just outside, before and after floods. This isolates climate risk effects from confounding factors like general economic conditions, with robustness checks including firm fixed effects and controls for borrower credit quality. The sample spans diverse regions, ensuring national representativeness.
Key Findings & Analysis
Post-flood, banks cut lending to high-risk zone firms by 15-20% in total credit volume, with effects strongest in the first year and fading but persisting up to three years. Small businesses, which rely on bank loans for 40% of financing per Federal Reserve data, face the sharpest declines, leading to 5-10% drops in local employment and output. These patterns hold across bank sizes but are pronounced for regional lenders more exposed to local risks, underscoring climate as a systemic credit channel.
Implications & Applications
Small business owners in flood zones may see denied loans or rates 1-2 percentage points higher, per related Fed studies, squeezing cash flow and forcing closures—relevant as 30 million U.S. small firms employ half the workforce. Homeowners could face spillover effects via reduced local economic activity, hiking personal borrowing costs. Policymakers might expand SBA disaster loans or incentivize banks via FDIC rules to maintain credit flow. Individuals should prioritize NFIP flood insurance, which cuts perceived risk and aids loan approvals.
Looking Ahead
Future research could extend to hurricanes, wildfires, and droughts, testing if lending contractions amplify via supply chains. Limitations include focus on floods only and pre-2025 data, missing recent supercharged events; updated panels post-Hurricane Helene would refine estimates. Watch for regulatory responses, like Fed stress tests incorporating climate scenarios, and private adaptations such as parametric insurance for firms. Banks may increasingly use AI-driven flood modeling, potentially deepening or mitigating credit gaps.