A climate stress testing exercise on loans to European small and medium enterprises

We develop a micro-level climate stress testing framework to evaluate the financial performance of small business loans under diverse climate scenarios. Focusing on European small and medium-sized enterprises (SMEs), we estimate the impact of coastal, flash, and river floods on loan default risk using a discrete-time survival model. Our analysis reveals that flood events significantly increase SME loan default probabilities in countries such as Spain and France. However, this effect is notably reduced in regions with strong infrastructure or effective support mechanisms. To complement the empirical findings, we conduct a forward-looking stress testing exercise that projects default probability trajectories under varying flood severity scenarios. This approach enables financial institutions and regulators to quantify the loan-level credit risk associated with climate-related flooding, offering valuable insights for risk management and policy design. • Climate stress test of SME loans in Europe using micro-level survival modelling. • Floods significantly raise SME loan default risk in Spain and France. • The impact of flooding is lower where structural defences and aid support are high. • Granular spatial and climate data are key for accurate SME stress testing.