How heatwaves lead to financial distress

Natural disasters can have serious financial impacts, from causing large insured losses to disrupting supply chains. But new research from the Bank of Canada finds that more routine climate stress can also hurt household finances by increasing demand for payday loans and increasing defaults.

In a new report, researchers at the central bank examined the effects of extreme temperatures, such as heatwaves and deep freezes, on the finances of low- and middle-income households using novel data on payday loans.

“We find that having more extreme temperature days increases the demand for payday loans but decreases the total credit issued,” it said.

“Additionally, we show that the negative impact on vulnerable households can be amplified through potentially disastrous debt cycles, featuring increasing delinquency and default rates.”

The research examines the effects of daily temperature extremes, which occur more frequently than full-scale natural disasters such as earthquakes and hurricanes, impacting large populations and agricultural zones. 

Very hot and very cold days can impact household finances by decreasing employment income, increasing heating and cooling costs, and increasing health expenses, the paper suggested. 

Indeed, the research found that “[t]otal inquiries for payday loans significantly increase with more extreme heat or cold days.”

But while episodes of extreme heat and extreme cold drive increased demand for payday loans, the researchers found that hot and cold weather has disparate impacts on credit issuance and the performance of existing loans.

“Extreme heat days significantly reduce total credit issued,” they found.

Specifically, one extra extreme heat day per month is associated with a 0.4% drop in credit issued, it said, adding that they also observed significant increases in delinquency and default rates. 

However, they found that while payday loan demand increases during extreme cold days, freezing temperatures do not affect credit issuance or performance of existing payday loan accounts. 

“Taken together, our results suggest that payday loan lenders reduce credit supply during extreme heat days out of concern for an increase in default and delinquency rates,” it said.

Additionally, they found that extreme heat days negatively affect income, but that extreme cold days do not reduce income. 

“Our findings highlight the heightened financial vulnerability of low-income households during extreme weather events and underscore the urgent need for targeted interventions and policies,” the report said. 

“Developing strategies to mitigate the adverse impacts of climate change on vulnerable individuals and assisting low-income households in building resilience against these challenges is essential.”