CLIMATE-INDUCED CREDIT RISKS AND THE FINANCIAL STABILITY OF COMMERCIAL BANKS IN KENYA
CLIMATE-INDUCED CREDIT RISKS AND THE FINANCIAL STABILITY OF COMMERCIAL BANKS IN KENYA
Ruth Mwaura - Postgraduate Student, Department of Accounting and Finance, Kenyatta University, Kenya
Dr. Farida Abdul - Senior Lecturer, Department of Accounting and Finance, Kenyatta University, Kenya
Dr. Vincent Shiundu Mutswenje (Ph.D) - Department of Accounting and Finance, Kenyatta University, Kenya
ABSTRACT
Commercial banks remain central to credit intermediation, savings mobilization, and payment systems, making their stability essential for sustained economic growth. In Kenya, this stability has been increasingly tested by climate variability heighten financial risks. Sector-wide resilience, measured by the average Z-score, fell sharply from above 100 in 2010 to about 18 in 2013, before settling in a range of 26 to 40 between 2021 and 2024. Although climate shocks are now recognized as key threats to banking systems, empirical evidence on their precise impact, particularly through mediation and moderation channels, has been mixed. This study examined how climate-induced credit risk affect the financial stability of commercial banks in Kenya. The analysis was anchored on Credit Risk Theory and Financial Sustainability Theory. A census of all 39 commercial banks was undertaken using secondary data from audited bank statements, Central Bank of Kenya supervision reports, macroeconomic bulletins, and climate-event records covering the period 2010–2024. Financial stability was proxied by the Z-score, while earnings volatility was measured as the rolling standard deviation of return on assets. Fixed effects panel regressions confirmed that climate-induced credit risk (p<0.001) significantly reduced financial stability. The study concludes that climate-induced credit risk exerts a structurally destabilizing influence on the banking system, as sustained exposure undermines loan portfolio quality and heightens systemic fragility. It is recommended that the Central Bank of Kenya and the National Treasury revise prudential guidelines to require integration of climate-adjusted credit default probabilities into capital adequacy computations and credit portfolio risk weighting.
