Bangladesh’s banking sector could face mounting financial strain in the years ahead as climate change slows economic growth, drives up loan defaults and erodes bank capital, according to the first-ever climate stress testing exercise conducted by the Bangladesh Bank (BB).
The central bank’s Financial Stability Department published recently has warned that climate-induced shocks to the economy could significantly increase credit losses across the banking sector, exposing vulnerabilities that may threaten financial stability if urgent action is not taken.
The central bank’s report is echoed the concern of the World Bank that has warned Bangladesh that its banking sector is increasingly exposed to the growing fallout of climate change as extreme weather disasters and the global shift towards greener economies threaten to inflict heavy losses on banks through rising bad loans and shrinking asset values.
Extreme weather events-such as acute floods, wildfires, and typhoons, alongside chronic temperature rises-directly cripple a borrower's capacity to service debt.
The BB’s findings emerged from a comprehensive scenario-based climate stress test that assessed how different climate change pathways could affect banks through their impact on the country’s GDP growth and overall economic performance.
The study found that more severe climate damage scenarios would consistently result in higher loan losses for banks, highlighting the sector’s substantial exposure to climate-related economic disruptions.
“Immediate climate action is essential to minimise potential losses,” the report said, stressing that delays in addressing climate risks could amplify financial vulnerabilities and increase pressure on banks’ balance sheets.
Using data up to March 2024, the central bank adopted a top-down stress testing approach, linking projected climate-driven changes in GDP growth to banks’ credit risk through econometric modelling. The exercise then assessed how climate-induced economic slowdowns could affect banks’ capital positions and asset quality.
Although the report does not recommend immediate increases in regulatory capital requirements, it aims to alert policymakers, regulators and financial institutions to the growing risks posed by climate change.
The findings underscore the need for banks to integrate climate risks into their core business strategies, strengthen provisioning against potential losses and develop institution-specific climate risk management frameworks.
The report also highlighted serious gaps in climate-related data, calling for more reliable data collection, disclosure and reporting systems to improve risk assessment and policy responses.
Bangladesh, one of the countries most vulnerable to climate change, faces increasing threats from floods, cyclones, river erosion, salinity intrusion and extreme weather events, all of which could undermine economic growth and affect borrowers’ repayment capacity.
The central bank cautioned that climate-related economic disruptions could weaken the financial health of businesses and households, leading to a deterioration in loan portfolios and rising non-performing loans across the banking sector.
While acknowledging certain limitations-including the use of hypothetical climate scenarios, static balance-sheet assumptions and a relatively short projection horizon-the report described the exercise as a crucial first step towards developing a more sophisticated climate risk assessment framework.
The study marks a significant milestone for Bangladesh’s financial sector as it represents the country’s first climate stress test based on scenario analysis for banks.
To strengthen future assessments, Bangladesh Bank has already revised its stress testing guidelines to incorporate climate change considerations and has begun introducing a bottom-up climate stress testing model.
The central bank has also received technical assistance from the International Monetary Fund (IMF) to enhance climate risk analysis and develop more advanced methodologies incorporating hazard projections, damage estimation models and exposure assessments.
Officials believe these improvements will help build a more resilient, climate-aware banking system capable of withstanding the growing economic shocks associated with global warming.
The report comes at a time when regulators worldwide are increasingly urging banks to recognise climate change not only as an environmental challenge but also as a major financial stability risk with far-reaching implications for economic growth and the health of the banking sector.
