Water Stress, Agricultural Exposure, and Banking Fragility: Evidence from Tunisian Governorates

This paper examines how hydrological stress propagates into banking sector fragility through the agricultural credit channel in a climate-vulnerable emerging economy. Using a novel governorate-level panel dataset covering Tunisia over the period 2003-2023, we estimate a two-way fixed effects model that interacts a water stress index with local agricultural employment intensity. We provide the first sub-national evidence showing that the impact of water stress on agricultural non-performing loans (NPLs) is significantly amplified in regions with greater agricultural dependence. The estimated interaction effect is large, robust across specifications, and economically meaningful. We further document a non-linear relationship characterized by a threshold beyond which the marginal effect attenuates, consistent with endogenous credit rationing. Dynamic specifications reveal strong persistence in NPLs, implying a substantial long-run amplification of climate-related shocks. Importantly, we identify a structural break following the 2011 revolution, suggesting that institutional reforms and public credit programs significantly mitigated the transmission of water stress into banking risk in the subsequent period. Our findings contribute to the climate-finance literature by highlighting the importance of sectoral exposure and regional heterogeneity in shaping financial vulnerability to physical climate risk. They also carry direct implications for climate stress testing, macroprudential regulation, and the design of agricultural risk-sharing mechanisms in water-scarce economies.