Climate Risk Flashcards
OECD estimate on required investment.
OECD estimate that $6.9tn required each year until 2030 to meet Paris Agreement goals on global warming.
Climate risk definition
The potential financial impact of climate change on banks operations, investments and loan portfolios. Both physical risk and transition risk
What is physical risk element of climate risk
Risk associated with direct and indirect impacts of climate change on a banks operations, investments and loan portfolio. Both acute and chronic risks.
Acute physical risk
Extreme weather events that can lead to direct or indirect financial losses. e.g floods causing property damage.
Chronic risks
Long term shifts in climate patterns that can affect asset values, economic productivity and creditworthiness of borrowers. e.g rising temperatures or sea levels.
Example of recent acute risk
Dubai Floods, April 2024. Floods caused $1bn damage in 1 day. Banks deferred personal car loan instalments for 6 months.
What is transition risk
Risks arising from the transition to a low carbon economy, such as changes in policies, technology, markets or consumer preferences related to climate change mitigation and adoption.
Policy and legal risks from transition
Regulatory changes can increase operational costs or introduce new taxes. Companies may face lawsuits from environmental damage or non-compliance.
Technology risks from transition
Implementation of new technology can be costly for companies.
Market risks from transition
Shifts in supply and demand for certain products as consumer preferences change
Reputational risks from transition
Reputation may be (damaged)/ enhanced by (non) adoption of sustainable practices.
Climate risk spillover on other risk categories:
Credit risk- Borrower exposure to climate risks. Market risk- fluctuations in asset prices due to climate change. Operational risk- disruptions to banking operations. Liability risk- legal exposure to climate-related damages
How to assess climate risks in banking sector
1) Identify and measure climate risk exposure 2) Stress testing and scenario analysis
How to identify and measure climate risk exposure
Recognise risks and map to relavant bank activities. Quantify financial exposures, incorporating credit risk metrics into existing risk management frameworks.
Stress testing and scenario analysis
Stress testing- simulate extreme but plausible climate events, evaluate potential impact on banks capital, liquidity and profitability. Identify vulnerabilities. Scenario analysis- simulate extreme but plausible events, assess potential impact of each scenario on banks business model, strategy and risk profile.
Types of climate risk data
1) Climate and environmental data 2) Policy and regulatory data 3) Technological and market data 4) Company and sector specific data 5) Geospatial data
Climate Risk data issues
Availability and quality of data. Limited historical data and inconsistency.
How to mitigate climate risk: Key points:
1) Integrate climate risk into risk management frameworks 2) Enhance risk identification and assessment 3) Reduce exposure to high risk sectord and assets 4) Promote green financing and sustainable investing 5) Improve climate risk disclosure and transparency 6) Embed sustainability in corporate culture
How to integrate climate risk into risk management frameworks
Incorporate into all existing risk mgmt frameworks. Develop policies, procedures and governance structures to address climate risks across organization. Establish clear roles and responsibilities for climate risk manegemtn in bank.
How to enhance risk identification and assesment
Use robust data and analytics to identify and assess climate related risks in a banks operations, investments and loan portfolios. Develop sector specific and geographic risk assessments to understand exposure. Monitor emerging risks and trends related to climate change and transition
How to reducd exposure to high risk sectors and assets
Assess exposure to high carbon industries and assets that may be at risk from climate change impacts or transition. Develop strategies to reduce exposure to these high risk sectors and assets over time. Consider reallocation capital to lower risk, more sustainable investments and lending opportunities.
How to promote green financing and sustainable investing
Expand financing and investment opportunities for green projects. Develop and promote sustainable financial products. Collaborate with clients to support transition.
How to improve climate risk disclosure and transparency
Adopt and implement TCFD recommendations or similar frameworks to improve climate risk disclosure. Provide clear, consistent and comparabl einfo on banks climate risk exposures, management practices and performance metrics. Engage with stakeholders to communicate banks approach.
How to embed sustainability in corporate culture
Embed into banks corporate values and culture. Ensure commitment to addrssing climate risk comes from top. Encourage employees to consider climate risk and sustainability in daily decision making and activites.
Use of derivatives to hedge climate risk
Climate/weather derivatives such as WeatherXchange provide options, futures and forwards to insure industries such as agriculture.
Regulatory initiatives to face climate risk
TFCD, NGFS, ECB, BoE and FED
TCFD initiatives
Task force on Climate related Financial Disclosures. Develops voluntary, consistent climarte related financial risk disclosures.
NGFS initiatives
Network for Greening Financial System. created by 8 CB’s and regulators. Contributes to development of climate risk management in financial sector.
How to future proof against climate risk
Adjust risk appetite, create climate risk regisrer, conduct framework gap analysis, quantify and measure climate risks.
