Climate change and systemic risk: The intermediary role of asset volatility

Background: The escalating impact of climate change on financial systems signals an urgent need to enhance risk management within the banking sector. Addressing this challenge is particularly critical for South Africa, where climate-induced systemic risks are increasingly evident. Aim: This study investigates the role of climate change in driving systemic risk within South Africa’s banking sector, focussing on asset volatility as a mediating factor. Setting: Quarterly data for South Africa from 2002 to 2020 were used in this study. Method: The study utilises Bayesian Model Averaging and Structural Equation Modelling along with the Baron and Kenny mediation approach. Results: The findings reveal a positive relationship between climate change and bank systemic risk, with asset volatility acting as a partial mediator suggesting that climate-induced risk elevates bank systemic risk in South Africa Conclusion: The study underscores the need for cohesive risk management strategies that integrate both macro-prudential regulatory perspectives and micro-risk management practices to mitigate climate-induced systemic risks. Contribution: This study contributes to the understanding of the impact of climate change on systemic risk in South Africa’s financial system by using the component expected shortfall method to quantify risk. By using asset volatility as a mediator and the ND-GAIN Climate Vulnerability Index, the study offers a nuanced, multidimensional view of how climate risks affect financial stability.