Unlike hurricanes and floods, which arrive suddenly and tend to dominate headlines with dramatic images of wrecked homes and submerged towns, droughts are often overlooked by media , governments and markets because they unfold more slowly.
Authors
- S. Mehmet Ozsoy
Assistant Professor of Finance, Concordia University
- Erkan Yonder
Associate Professor of Finance and Real Estate, Concordia University
Their gradual toll on fields, reservoirs and rural communities tends to be overshadowed by flashier disasters, but their consequences are no less severe.
A drought is a shortage of precipitation - typically lasting a season or longer - that results in insufficient water availability for ecosystems, agriculture and human use.
As climate change accelerates, droughts are projected to become more frequent and intense , especially in dry regions. This makes it increasingly urgent to understand their complex impact on agriculture, water supplies and regional economies.
Droughts don't just hurt farmers
Droughts barely register in financial markets, despite their widespread consequences. Yet research shows that droughts can slash food industry profits by increasing farming costs, disrupting supply chains and tightening profit margins.
Droughts hit utilities and agriculture hardest. Shrinking water supplies wilt crops and strain water providers. But the impact extends far beyond them: low river levels can stall hydropower production , pushing up electricity costs and affecting water-heavy industries like textiles and chemicals.
Shallow waterways can also delay or block barges carrying goods , which hikes shipping costs . These disruptions ripple outward, affecting everyone from factory workers to shoppers.
Yet markets often ignore these risks until damage becomes impossible to overlook . With climate change poised to make droughts more frequent and severe, this blind spot could pose growing risks to investors and the stability of food supply chains.
Banks reveal the economic toll of droughts
Climate shocks like droughts hit local economies hardest - especially small, private businesses. While researchers can access financial data for public companies, the finances of private firms are far more opaque, making it difficult to understand the local impact of droughts.
To address this gap, we studied how prolonged droughts affect the financial stability and loan performance of regional banks across the United States. The stability, or fragility, of these banks can sway the economy, as seen in the 2008-09 crisis.
By examining bank balance sheets, we traced the broader economic ripples of droughts and found that a two-year drought can have the same economic impact on a region as a one-percentage point increase in the unemployment rate.
Communities suffer when banks do
Smaller banks are closely tied to their communities and often lend locally - often within just five miles - making them especially vulnerable when droughts strike. As small firms struggle to repay loans in the wake of such disasters, banks see an increase in missed payments.
Our data shows that droughts disrupt entire communities as job losses and tight budgets create a domino effect throughout local economies.
Banks in drought-hit areas see lower profits and rising risks. Unpaid loans, or "non-performing loans," spike not just for farmers but for homeowners, businesses and commercial properties.
When farm workers lose income from unplanted or failed crops, they may fall behind on mortgage payments, even if farms themselves are insured.
Missed mortgage payments signal household distress, while defaulted business loans hit farms, food producers and service providers like caterers as customer demand dries up. Reduced wages also means less spending at local restaurants, equipment stores and other small businesses.
Unlike hurricanes or floods - which are designated disasters by the U.S. Federal Emergency Management Agency - droughts receive no such status.
Once a flood or hurricane is declared a federal disaster, U.S. federal agencies provide financial assistance to eligible households and businesses. FEMA offers several programs , including financial assistance for temporary housing, home repairs and the replacement of personal property.
FEMA also supports the Disaster Unemployment Assistance and the Dislocated Worker Grant program . In addition, the Small Business Administration provides long-term, low-interest loans to eligible businesses and some homeowners, while the IRS (Internal Revenue Service) offers administrative disaster-related tax relief .
Because droughts don't have access to the same resources, banks and local economies are left to cope on their own instead of receiving emergency aid from FEMA. As a result, our research found that banks are more likely to close branches in drought-hit areas. These closures can make recovery even harder for local businesses left reeling from droughts as they lose vital loan access.
Diversification offers some protection
From banks reeling with unpaid loans to families struggling to make ends meet, the fallout from droughts is real and far-reaching. Droughts don't just dry up water - they drain livelihoods and destabilize economies.
Larger banks and firms with operations across multiple states are better able to weather climate shocks. This diversification acts as a form of self-insurance, helping them absorb losses in one region while staying afloat in others.
This might explain why stock markets often ignore the risks posed by droughts. Large players are less exposed to local downturns. But smaller, more vulnerable businesses that are reliant on local stability don't have the same buffer.
As these crises grow more common, markets, regulators and policymakers need to rethink how droughts are measured and mitigated before entire communities are left behind.
Regulators have begun to take some notice. Climate risks are now formally recognized as threats to financial stability by the Financial Stability Board , an international body that monitors the global financial system.
Still, recognition is only the first step. Without concrete action, droughts will continue to destabilize communities.
Erkan Yonder receives funding from Fonds de recherche du Québec (FRQ).
S. Mehmet Ozsoy does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.
