Climate Change and Financial Stability: Evidence from Southern Africa Working Paper 933

Climate change poses increasing risks to financial stability, yet empirical evidence from small African economies remains scarce. This paper provides systematic estimates of the impact of temperature shocks on banking sector stability in Lesotho, Eswatini and Namibia over the period 2009 - 2023. Using the Local Projections (LP) method, results show that increases in temperature are associated with sustained growth in non-performing loans (NPLs), indicating rising credit risk and a weakening banking environment in the face of climate shocks. To complement these findings, a two-way fixed effects model with mediation analysis is employed, testing GDP as a transmission channel. The results suggest that while GDP does not significantly mediate the relationship, temperature shocks exert a robust and direct effect on banking stability. The study contributes new evidence an climate- finance linkages in climate-vulnerable, agriculture-dependent economies and underscores the need for supervisory frameworks and climate-related stress testing to integrate physical risk into financial assessments.