Physical climate risks play a significant role in shaping collateral practices. Using comprehensive loan-level data covering all bank loans to firms in Sweden, we document that extreme weather events significantly influence banks’ collateral requirements for new loan originations and their reappraisal practices for existing loans. Specifically, adverse weather events increase the likelihood that new loans are collateralized and lead to higher collateralization levels for such loans. However, for existing loans, banks are less likely to reappraise real estate collateral following a weather shock, potentially delaying the recognition of value impairments. When reappraisals do occur, the collateral values are, on average, revised downward. Notably, we also find that extreme weather events do not directly influence the one-year default probabilities calculated by banks, highlighting a potential gap in the integration of physical climate risks into traditional credit risk assessments.

We uncover a robust positive relationship between a bank’s share of retained mortgages and subsequent bank performance. This relation is time-varying and depends on the business cycle. During crises, when house prices decline and delinquencies increase, high-retained- share banks report higher profitability than other banks. The relation is reversed during expansion periods when house prices rise and delinquencies are typically low. We provide evidence that banks’ internalization of fire sale externalities acts as a main channel with important real effects: high-retained-share banks originate higher loan volumes at more favorable terms and indirectly affect the performance of banks active in the same region. Further evidence confirms that this channel is different from alternative explanations based on market power, relationship effects, diversification, or informational benefits.

This paper examines how banks’ incentives to internalize the spillovers from natural disasters affect their credit lending. Using data on small business loans and damage estimates from natural disasters, I find that banks with a large lending share in a local market provide more credit to mall firms during the recovery periods than other banks. This finding implies that banks recognize the benefits of alleviating liquidity constraints for distressed borrowers, which lowers their default risk and preserves future business opportunities. Furthermore, I document that disaster-affected local areas with high-lending-share banks experience a smaller employment contraction than other disaster-affected areas, highlighting the importance of bank lending in disaster recovery and resilience.

I quantify the costs of realized flood disasters for banks and create a novel measure of bank-level flood risk exposure using expected flood risk estimates and mortgage lending data. I document that banks with large shares of mortgages in affected areas experience lower profits and capital ratios following flood disasters. In the cross-section of stock returns, small banks with high exposure to flood risk underperform other banks, on average, by up to 9.6% per year; this implies that exposure to flood is not fully priced. Underperformance persists when controlling for the negative effects of disasters on realized returns and adjusting for investors’ climate change concerns. The findings support regulatory concerns that bank equity is exposed to physical risk from climate change.