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The global financial sector is at a pivotal crossroads as climate change intensifies. From rising sea levels to unprecedented heatwaves, institutions face mounting risks that can no longer be ignored. Successfully navigating this landscape requires integrating climate considerations into core risk frameworks and business strategies.
With the costs of extreme events soaring and policy shifts underway, the time for robust action is now. Financial leaders must embrace both the challenges and opportunities presented by a low-carbon transition.
Financial institutions worldwide are grappling with a complex array of risks stemming from climate change. Physical risks arise from acute phenomena such as extreme weather events connected to climate and chronic shifts like sea level rise. These events can trigger direct asset damage and indirect effects, including public health crises marked by increased mortality and morbidity.
Transition risks emerge as economies shift toward a low-carbon model, introducing regulatory reforms, technological innovations, and market realignments. Abrupt policy changes or technological disruptions can lead to stranded assets and valuation shocks, undermining balance sheets if not anticipated.
Liability risks involve potential legal exposure to claims for inadequate disclosures or failure to adapt assets to emerging climate realities. Meanwhile, amplification effects can transmit these challenges across geographic, sectoral, and financial networks, exacerbating potential systemic consequences.
Since 2000, the reported costs associated with climate-driven weather events have nearly tripled. Losses climbed from $149 billion during 2000–2004 to an estimated $435 billion for 2020–2024. This dramatic escalation puts immense pressure on insurers, which may withdraw coverage from high-risk regions, leading to credit freezes for assets deemed uninsurable.
As insurers pull back, banks and investors could face substantial provisioning costs and increasing capital requirements. Non-linear tail risks, where rare but severe events occur, further complicate forecasting and contingency planning.
To navigate an uncertain future, the Network for Greening the Financial System (NGFS) has developed four short-term scenarios that capture the interplay between policy responses and physical impacts. Each narrative illustrates potential outcomes for asset valuations, risk premia, and sector exposures.
In a disorderly transition, risk premia could spike, driving sharp declines in asset prices. Conversely, delayed action may lead to mounting physical damages, amplifying credit losses and liquidity strains across banking and insurance sectors.
These systemic risks are intertwined, meaning a shock in one area—such as a sharp policy shift—can cascade through global capital flows and impact market confidence in other regions.
Institutions are refining methodologies to capture the full spectrum of climate-related risks. Key elements include:
Regulators now emphasize mandatory disclosures, scenario analysis, and standardized risk metrics. The Financial Stability Board’s roadmap provides a global blueprint for data harmonization, capacity-building, and collaborative governance.
Implementing these practices demands significant investment in data infrastructure, model validation, and staff expertise. Institutions that embed climate risk into enterprise risk management frameworks position themselves for enhanced resilience and competitive advantage.
Beyond mitigating risks, the financial sector can drive the transition to a sustainable economy. Through innovative funding mechanisms and partnership models, banks and asset managers play a vital role in scaling climate solutions.
International organizations, such as the IMF, highlight the importance of an enabling environment. This includes clear policy signals, robust legal frameworks, and incentives for both public and private investors.
By mobilizing private and public funds effectively, institutions can help close the multitrillion-dollar gap in financing needed to achieve global climate goals and foster sustainable development in vulnerable regions.
Effective risk management depends on coherent and forward-looking regulatory frameworks. Significant milestones include the Climate Change Financial Risk Act of 2025, which mandates scenario analysis, risk assessments, and enhanced disclosures for major financial entities.
At the national level, regulators like OSFI have issued guidance on integrating climate risks into capital planning, liquidity management, and governance. Requirements now call for robust planning, stress testing, and transparent reporting to stakeholders.
The FSB’s roadmap underscores the need for sequenced policy actions: first building data quality, then refining risk metrics, and finally enforcing consistent disclosure standards. This phased approach helps institutions adapt without overwhelming operational capacities.
Continued evolution of best practices and international coordination will be crucial to ensure that policy developments reflect the latest scientific insights and market innovations.
Climate change represents both a profound risk and an unprecedented opportunity for the financial sector. By embedding climate considerations into mainstream risk management, investing in resilient infrastructure, and deploying capital toward green solutions, institutions can support a sustainable and prosperous future.
Success requires collaboration among regulators, academia, and the private sector to foster innovation, share best practices, and maintain momentum. With robust scenario analysis and forward-looking governance coupled with just and inclusive policy approaches, the financial community can help steer the global economy toward a resilient, low-carbon pathway.
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