costs during the transition towards a greener, carbon-neutral economy. These risks could be related to climate policies, technological change or shifts in investor and consumer sentiment with respect to climate change and the preservation of the environment. As for physical risks, transition risks could be mild if the economy transforms smoothly over time. Yet, if intervention and adaptation are delayed, changes in policy and taxation might be abrupt, leading to significant adjustment costs for companies and households. Financial assets may become stranded, increasing the chance that borrowers are unlikely to repay their debt obligations with negative repercussions for lenders.

Using a large, unbalanced panel dataset consisting of 184 countries over 1980-2019, we contribute to a growing literature by presenting the first systematic cross-country evaluation of the effect of a wide range of climate and environmental related natural disasters on the stability of the banking sector, with a focus on bank asset quality. We find that severe natural disaster episodes can lead to an increase in the level of system-wide non-performing loans(NPLs) to total gross loans (henceforth NPL ratios), and the effects can be persistent. For our global sample, NPL ratios are estimated to increase by 0.37 percentage points one year after disaster episodes associated with an official declaration of emergency. Two and three years after an episode involving multiple types of disasters, the cumulative increases in NPL ratios stand at 0.56 and 0.6 percentage point on average respectively. The relationship between severe climate and environmental related disasters and the level of system-wide NPL ratios is observed across multiple World Bank regions,1 including in East Asia and Pacific (EAP), Latin America and the Caribbean (LAC), South Asia (SA) and SubSaharan Africa (SSA). Moreover, this relationship is also observed across almost all income groups except for lower-middle-income countries. These results should be interpreted with caution due to a limited sample at the country-year level and a lack of a generally consistent cross-country source of major natural disasters.

To address important caveats of the cross-country results regarding data granularity and quality, we also present results from a country-specific example. Using banking sector data at the regional level, we study the impact of typhoons on NPL ratios between 2011 and 2018 for the Philippines, a country highly exposed to climate related natural disasters. We find that a 1 percentage point increase in the typhoon damage ratio, defined as the amount of damage divided by regional GDP, could lead to an increase in the NPL ratio as large as 2.3 percent, an estimate larger in magnitude than these found for the cross-country sample. On balance, although the magnitude of our empirical results should be taken with caution due to concerns on data quality and granularity, the qualitative relationship between disaster episodes and NPLs seems reasonably robust.

Beyond the effects on bank asset quality, we also find tentative evidence that severe climate and environmental related natural disaster episodes may be associated with several other key banking sector variables, such as net interest margin, capital adequacy, credit to the private sector and liquidity-to-deposit ratio. For certain definitions and time horizons, these disaster episodes are found to be associated with: 1) increases in net interest margins, and hence higher cost of financial intermediation; 2) an increase in regulatory capital adequacy; 3) an increase of bank credit to the private sector; and 4) a decrease in liquid assets relative to deposits. While we do not identify a specific causal chain, our results point to multiple channels from physical risks to financial

> 1The World Bank country regional classification is available at the following link: https://datahelpdesk.worldbank. org/knowledgebase/articles/906519-world-bank-country-and-lending-groups.

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