Floods impair Japanese banks, collateral value drives losses

The Bank of Japan working paper, using granular municipality-level data from Japan, reveals that flood exposure adversely affects banks' financial conditions.

Researchers found elevated non-performing loan (NPL) ratios and credit cost ratios, alongside reduced returns on assets (ROA).

Simultaneously, banks expand credit supply in affected regions, likely driven by heightened demand for reconstruction and liquidity.

However, the estimated magnitudes of these impairments are economically small relative to their average levels, suggesting that the overall impact of floods on banks' financial conditions has been quantitatively limited thus far.

This dual response highlights the complex interplay of damage and recovery needs.

The study identifies heterogeneous responses among banks, with those exposed to regions experiencing sharp land price declines following floods facing larger drops in financial performance and a more muted expansion of credit.

These effects are particularly pronounced for banks with a high proportion of their total lending secured by real estate.

This suggests that the depreciation of collateral value serves as an important transmission channel for climate-related physical risks to the banking sector.

This paper is the first to explicitly examine the collateral channel empirically, providing new evidence for Japan and confirming its robustness across diverse institutional environments.