Impacts of Climate Change on Loan Performance: Vulnerabilities and Adaptation Strategies for Rural Households and Lenders

We use proprietary loan-level data from one rural commercial bank in China from 2000 to 2019 to investigate the impacts of climate change (CC) on rural households’ loan performance. We develop two proxies to measure loan exposure to CC by using the absolute deviations of exogenous location-specific temperatures and rainfalls from historical patterns over the loan duration. Our results suggest that a one-unit increase in abnormal temperature and rainfall is associated with a 1.39 per cent and 7.64 per cent higher likelihood of default, respectively. Moreover, we find that CC has heterogeneous impacts on the repayment performance of agricultural production loans (APLs) and non-agricultural production loans (NAPLs). Specifically, APLs are vulnerable to CC as its adverse effects are significant across all quintiles of abnormal temperature and rainfall. In contrast, NAPLs are only sensitive to extreme weather conditions, which fall within the highest quintiles. Lastly, we provide valuable insights into mitigation strategies from the perspective of rural households and lenders. Our results indicate that improving income streams and adopting advanced production technology could be two effective mechanisms for rural households to enhance their ability to repay loans. However, using (liquid) collateral cannot significantly reduce the vulnerability of loan performance to CC for lenders.