Climate change poses a major financial risk to banks — not just an environmental issue, but a strategic and regulatory one. As global temperatures rise, physical and transition risks can threaten the solvency of borrowers, the value of collateral, and the broader stability of the financial system.
🔍 1. What Is Climate Risk?
Climate risk refers to the financial risks caused by climate change. These risks can directly impact a bank’s loan portfolio, asset value, operations, and reputation.
There are two main types:
| Type of Risk | Description |
|---|---|
| 🌪 Physical Risk | Risk from climate-related events — storms, floods, droughts, wildfires |
| 🔁 Transition Risk | Risk from policies, technologies, or market shifts as the world moves to a low-carbon economy |
🏦 2. Why Is Climate Risk Important for Banks?
Banks face climate-related risks through:
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Loan Defaults: Borrowers (e.g., farmers, energy companies) affected by climate events may default.
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Asset Devaluation: Properties in flood-prone areas may lose value.
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Regulatory Risk: Central banks and regulators may impose carbon-related regulations (e.g., higher capital requirements).
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Reputation Risk: Financing polluting industries could damage the bank's image.
🔎 3. Key Tools & Approaches
✅ Climate Risk Stress Testing
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Simulating how a bank’s balance sheet would react to extreme climate scenarios (e.g., sea level rise, carbon pricing).
✅ ESG Risk Scoring
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Assessing environmental, social, and governance risks of borrowers and investments.
✅ Scenario Analysis
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Using models like those from the Network for Greening the Financial System (NGFS) to estimate risks under various policy paths (e.g., orderly vs. disorderly transition).
✅ Green Taxonomy & Disclosure (e.g., TCFD)
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Aligning with frameworks like the Task Force on Climate-Related Financial Disclosures (TCFD) to report exposure and actions.
🧾 4. How Central Banks Respond
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European Central Bank (ECB): Conducts climate stress tests, requires ESG disclosures.
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Bank of England: Introduced the Climate Biennial Exploratory Scenario (CBES) for UK banks.
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Central Bank of Uzbekistan (emerging): Exploring sustainable finance regulations and green credit incentives.
📊 5. Integration into Risk Management
| Risk Area | Climate Integration Strategy |
|---|---|
| Credit Risk | Adjust loan pricing based on climate exposure |
| Operational Risk | Prepare for weather disruptions to branch networks or data centers |
| Market Risk | Adjust portfolio for sectors at risk from carbon pricing |
| Liquidity Risk | Monitor potential funding stress due to reputational damage |
| Strategic Risk | Shift strategy toward green financing and ESG-aligned products |
🌱 6. Real Bank Responses (Examples)
| Bank | Action Taken |
|---|---|
| HSBC | Phasing out coal financing by 2030 |
| BNP Paribas | Incorporates ESG scores into credit decisions |
| Bank of Uzbekistan (pilot) | Considering green credit guidelines for SMEs |
| World Bank/IFC | Offering green bonds and technical assistance |
🧠 7. Future Trends
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Mandatory climate disclosures (e.g., ISSB, EU CSRD)
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Integration of climate KPIs into credit scoring
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Green bonds and sustainable lending incentives
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Growing role of AI in climate risk analytics