Abstract
This thesis investigates the financial risks of climate change on microfinance institutions (MFIs). It sheds new light on the topic by (i) developing a novel index of systemically important MFIs and assessing their sensitivity to climate risk; (ii) examining the relationship between climate vulnerability, geographic expansion and credit risk in MFIs; and (iii) empirically analysing the overall performance of MFIs to different types of climate hazards.
Chapter 2 is the first to develop a novel index to identify globally systemically important microfinance institutions (SIMFIs) and further assess their sensitivity to climate risk. Using a global sample of MFIs, the study first constructs an SIMFI index building on measures used by financial regulators to identify systemically important banks (size, substitutability and interconnectedness). Two versions of this index are constructed, one weighted by financial value and another weighted by people (e.g. total borrowers). The index result shows that most of the top 40 assets-weighted SIMFIs fall in the ranking when the SIMFI index is people-weighted. We argue that in the context of MFIs, it is the people index that matters. Second, drawing on IPCC’s risk framework and proxies for its component parts (hazard, vulnerability and exposure), the essay assesses the climate risk-sensitivity of SIMFIs. The climate risk–adjusted SIMFIs index (CRSIMFIs) indicates that the hazard component causes the largest change in rankings between SIMFIs and CRSIMFIs. Though shareholder-owned MFIs dominate the list, non-shareholder MFIs tend to be more climate risk prone. We also find SIMFIs in South Asia and East Asia and the Pacific region face greater climate risks.
Chapter 3 investigates the association between climate vulnerability, geographic expansion and credit risk in MFIs’ loan portfolios. It is motivated by inconclusive evidence concerning the climate vulnerability–bank risk nexus and the geographic expansion–bank risk nexus. Applying system generalized method of moments (GMM) to a sample of global MFIs over the period 1999–2019, we report evidence that climate vulnerability and geographic expansion increase MFI credit risk. The risk is more pronounced for non-shareholder-owned MFIs compared to shareholder-owned MFIs. This suggests MFI expansion into climate prone regions is curtailed in the case of shareholder-owned MFIs to minimize credit risk, overshadowing the microfinance mission to provide banking services to the poorest and the most vulnerable. In addition, we report evidence that climate vulnerability moderates the consequences of geographic diversification in the microfinance industry.
Finally, Chapter 4 examines the relationship between MFI performance, measured by CAMELS factors, and different types of climate hazards. The results of a dynamic panel estimation applied to the sample of global MFIs identified in Chapter 3, suggest that MFI performance is significantly affected by climate hazards. Droughts, floods and landslides reduce MFI capital adequacy, storms and wildfires are associated with lower asset quality, storms increase costs per borrower suggesting poorer management quality, floods decrease MFI liquidity and droughts are associated with reductions in social mission. The findings are robust to different measures of climate hazard impacts. The results suggest that microfinance regulators should establish capital reserve requirements to absorb adverse climate shocks. Microfinance practitioners need to monitor MFI asset allocations with respect to acute hazards.