In Europe, the fastest-warming continent, the intensification of extreme weather events and changes in precipitation patterns have led to widespread and catastrophic flooding. Last year, storms and flooding affected an estimated 413,000 people, resulting in the loss of at least 335 lives. Material damage is estimated to amount to at least €18 billion, according to the 2024 European State of the Climate report from the Copernicus Climate Change Service and the World Meteorological Organization.
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The flooding in October that hit southeastern Spain and the Valencia province in particular took the heaviest toll. Intense and prolonged rainfall and river flooding led to 232 fatalities, and infrastructure damage and economic losses totalled around €16.5 billion. More than seven months later, the local economy has rebounded, thanks in part to public aid packages worth 0.5% of the country’s GDP. However, in early May, the same part of Spain found itself exposed again to the disruptive consequences of climate change when extreme weather hit.
The costs of flooding
The direct costs from the damage to public infrastructure and private assets are only part of the economic losses originating from flooding. The indirect costs might not be immediately visible, but they are certainly not less significant. Business interruptions reduce firms’ revenue and cash flows, straining liquidity and, in the worst cases, threatening their survival. In addition, the increasing likelihood of future flooding may be priced into the valuation of assets and real estate in areas exposed to these types of climate risks. Firms impacted by climate-related hazards might find it difficult to pay back loans or bonds, or to raise finance as physical assets that can be pledged as collateral for bank credit lose value. Ultimately, this can affect the stability of the financial system.
For these reasons, climate change is not just a long-term environmental issue, but a threat to our economy and financial systems now. Economists at the European Commission’s Joint Research Centre (JRC) have been conducting research to better understand how the links between the business sector and the financial system amplify its impact.
A JRC study of flood events between 2007 and 2018 finds that flooding significantly worsened the performance of European firms. Manufacturers exposed to flooding experienced reductions in sales, number of employees and the value of their assets. These impacts occurred in the year following the flooding and tended to be persistent, with no clear signs of recovery seven years after the disaster. Some firms even went out of business. The study also finds that companies in flood-prone areas were better able to weather the shock than businesses exposed to less frequent flooding. This is consistent with the fact that adaptation and protection measures reduce the impacts of flooding.
Threats to smaller firms
Water damage is particularly disruptive for companies that are highly indebted. A second JRC study zooms in on the mechanisms whereby financing choices, and reliance on bank loans in particular, amplify the impact of climate change. This study focuses on loans extended to small and medium-sized enterprises (SMEs) in Italy, Spain and Belgium between 2008 and 2019. It was motivated by the idea that smaller firms, which are more financially fragile than larger ones, might also be more vulnerable to the localised impact of climate-related hazards, not least because of their limited capacity to geographically diversify their operations and access market-based finance. The study shows that flood episodes under analysis strained SMEs’ ability to meet their debt obligations. Flooded firms were more likely to incur delays in servicing their loans and eventually fail to repay them, even two years after the disaster.
In turn, this entails losses for the banks that finance these firms. In general, if banks anticipate the impact of flooding on business operations, they could be expected to divert lending toward safer borrowers or charge a higher interest rate on credit extended to at-risk firms. Indeed, the study finds evidence that prospective flood risk is priced into new loans. In the period under analysis, the “flood risk premium” was especially high for loans to smaller firms and for those granted by local, specialised banks, both of which tend to have geographically concentrated activities that are more exposed to disaster impacts. Loans to borrowers exposed to high flood risk were 12 percent more expensive, all things being equal.
Thus, flooding causes worse financial conditions for businesses and exposes the banking sector to losses on their loan portfolios. The numbers can be staggering: days after the October 2024 flooding, the Spanish Central Bank said that banks’ exposure in the affected areas would total €20 billion, with €13 billion in household loans and €7 billion in business loans (60% to SMEs), impacting 23,000 companies and 472,000 individuals.
With extreme weather events becoming more frequent and severe, the direct and indirect costs of climate change are projected to increase, unevenly affecting households, firms and territories across Europe. Increasing investments in adaptation, eg in flood defence, and closing the climate insurance protection gap – the uninsured portion of economic losses caused by natural hazards – are crucial to increase the resilience of our economies and financial systems and preserve the wellbeing of our societies. The complex structure of investment incentives calls for a multilayered approach, with a mix of private and public funding and risk-sharing mechanisms.
