Abstract
This study investigates the impact of climate risks on the financial stability of banks using a comprehensive panel dataset of European banks covering the period from 2006 to 2021. We find that greater exposure to climate risk significantly undermines bank stability, with transition risk exerting a particularly strong destabilizing effect. This impact is especially pronounced among larger banks and those with stakeholder-oriented governance models, and it intensifies following the adoption of the Paris Agreement. Our findings reveal a non-linear relationship whereby higher levels of climate risk exposure lead to disproportionately greater financial instability. Further analysis shows that these effects are driven by heterogeneity in bank-specific characteristics and country-level factors. We also find that stricter climate-policy regimes, particularly during advanced phases of the EU Emissions Trading System, strengthen the adverse effect of transition risk on financial stability. This study underscores the importance of integrating climate risks into prudential regulation to enhance the resilience of the banking industry to climate-related shocks.