Climate stress testing for loans to European SMEs

25 November 2025

Using climate stress testing to analyse how floods affect bank loans to small and medium-sized enterprises (SMEs) in Europe.

Aerial view of a flooded street in a town

This analysis looks at how floods affect bank loans to small and medium-sized businesses (SMEs) in Europe. We find clear evidence that when floods happen in the area where a business is based, the chance that the business won’t repay its loan goes up. We suggest a method to test how the probability of repaying these loans changes under different climate-related situations, also known as climate stress testing exercise. This framework supports banks and regulators to better understand how much more likely each loan is to go unpaid in these adverse climate scenarios. Our method can also help identify which parts of Europe are more at risk from climate events like floods.

Key points for financial regulators

Floods significantly increase SME loan defaults
Natural disasters - especially floods - raise the risk of small businesses defaulting on loans, particularly in countries like Spain and France.

Micro-level stress testing reveals hidden vulnerabilities
The paper introduces a detailed climate stress test tailored for SME loans, capturing risk at the individual loan level. This approach uncovers vulnerabilities that broader, national-level models often miss, helping regulators and banks better allocate capital and target support.

Climate risk analysis for small businesses must be integrated into financial regulation
Climate-related physical risks, such as floods, should be factored into credit risk models and regulatory stress testing frameworks. Previous exercises were mainly focused on corporate loans, but small companies are often more exposed and less resilient to physical risks.

High-quality climate and location data is essential
Effective regulation and risk management depend on access to granular spatial data about extreme weather events and future climate scenarios. It is essential to provide financial institutions with a data infrastructure that supports robust and forward-looking financial oversight.