Indeed, banks are able to manage physical climate risks

4 February 2021 - Blog post - By : Romain HUBERT

Some of the heat waves and wildfires that were experienced in Europe and in the world in the summer of 2019 are symptoms of a climate that is already changing. These events may cause losses for banks and other financial institutions, which will therefore have to integrate climate change into their decisions. Regulators are also pushing in this direction. However, financial institutions have raised practical difficulties that questioned the feasibility of managing so-called “physical climate risks”.


For Romain Hubert from I4CE, financial actors can overcome difficulties if appropriate resources are provided. But other questions arise about the consequences of climate risk management by these actors. He shares his perspectives on the subject, after three years of research as part of the European ClimINVEST project.



A necessary exercise

Heat waves, wildfires, heavy rains and other climatic events will impact individuals, business activities and perhaps the stability of regions. This may result in difficulties for these actors to repay their loans to banks and provide financial returns to their investors, or result in an increase of insurance claims. As a result, bankers, investors, insurers and other financial actors are themselves exposed to these “physical climate risks” through their activities.


There is an urgent need for financial actors to investigate their exposure to physical climate risk. In 2018, insurers covered only half of the natural damage. With the climate degradation that is now inevitable throughout the coming decades, insurance premiums will increase rapidly and some risks will no longer be “insurable”.


Unfortunately, financial players still have a limited willingness to carry out such analyses. Most consider that the impacts of climate change will occur decades from now, well beyond the horizon of their loans and other financing tools. Financial regulators and supervisors call this the “tragedy of the horizon”.


To address it, regulators are asking financial actors to take these climate risks into account in their financing and investment decisions, and to explain how they do so. This challenges financial actors to find the right methods of analysis and management.



Feasibility issues are not insurmountable for banks: proof by experiment

As financial actors have attempted to analyze and manage their exposure to physical climate risks, they have raised questions of feasibility to the point of wondering whether analyzing and managing physical climate risk was not simply a challenge.


Take the example of banks. It is difficult to quantify the potential losses on a lending activity as a result of climate impacts. However, this financial estimate is traditionally used by risk departments and other teams to account for a risk in their decisions. In addition, it is often difficult to collect the extensive data on individual borrowers that is needed to understand how the borrower is exposed and vulnerable to climate impacts.


However, banks have shown that they can start managing these risks if they set aside their goal of producing a large amount of precisely quantified information on the risk of individual borrowers. The alternative method found by the banks consists of two steps. The bank starts by using a coarse-meshed physical risk rating system, as a first net to identify large pockets of risk exposure. It then asks questions to the borrowers identified as most at risk in the previous step, in order to understand their risk exposure in more detail and make a decision.


This approach is promising. It limits the amount of data needed, and mobilizes the bank to collect missing data while at the same time stimulating the borrower to become aware of and even manage its climate issues. The first step of the method, in the form of a rating, also makes it possible to bypass the difficulty of estimating losses while integrating a logic of evaluation of climate-related financial impacts.



… Provided that everyone dedicates appropriate resources to do so

After three years of work on the ClimINVEST project, we have become convinced that banks have the potential to carry out the analysis of this risk, when some of them even start to manage it. But we have to admit that it will be necessary to mobilize more human resources to ensure that all financial institutions properly take into account all physical climate risks in decisions relating to all their activities.


Human resources need to be mobilized in financial institutions as a priority. They must bring together their risk and CSR departments to organize pilot analyses of their portfolios, in order to build expertise and find processes that are favorable to physical climate risk management. In order to do so, they can rely on experts in these subjects and on free resources such as those made available by ClimINVEST: practical feedbackexplanation of available methods, and other educational materials.


The teams of financial institutions also need to collaborate with a larger set of stakeholders. This should help them in particular to continue mapping climate vulnerabilities in various sectors of activity, and to increase access to reliable and harmonized data. In Norway for example, financial institutions and municipalities are collaborating on a “knowledge bank” with restricted access due to confidentiality issues.


To gain momentum, sustained action by financial regulators and supervisors will remain key. Many financial players are dedicating limited resources to climate-related issues and prioritizing the topics to be addressed according to the regulators’ requests.



Another question to be asked now: what will be the consequence of banks’ decisions?

Let’s assume that banks start managing their exposure to physical climate risks. What will be the result? Will they engage in dialogue with the actors most at risk and stimulate or even finance their adaptation efforts? Or will they penalize the most vulnerable by imposing unfavorable conditions on them or even setting them aside? The answer is far from obvious. Some private financial institutions seem ready to consider adaptation finance as a new business opportunity. Nevertheless, a careful exploration of this topic is needed to help clarify the terms of the following debate: who will pay for the cost of financial risk related to climate impacts?


Project ClimINVEST is part of ERA4CS, an ERA-NET initiated by JPI Climate, and funded by RCN (NO), ANR (FR), NWO (NL) with co-funding by the European Union (Grant 690462).


To learn more
  • 01/20/2023 Foreword of the week
    2023’s resolutions for a reform of development finance

    2022 ended up on a consensus that the global financial architecture is no longer “fit for purpose”. In other words, the financial ecosystem created post-war to support international development – at the centre of which are the IMF and the World Bank who were joined later by other international public financial institutions – wasn’t designed to address the multiplicity of challenges the world is facing today, foremost among which climate change. Time is running, and the good news is that 2023 is set up to be a busy year with key events setting the milestones for a reform of the international financial architecture, including a Paris Summit in June. The year will close at COP 28, where we will officially take stock of current achievements.

  • 01/19/2023 Blog post
    Here’s to an impactful new year for financial reform

    2023 will be busy with many events organised to address different parts of the financial architecture reform, including a Paris Summit in June. Alice Pauthier from [i4ce] tells you more about this agenda and identifies two conditions for a successful reform process. First, it has to be led by countries’ financing needs… wheras we are still lacking a granular analysis of countries’ investment needs for a sustainable development. Second, it has to be guided by the objective of maximising the impact of public finance. What we should count is the impact of public finance on the transition and not only volumes.

  • 01/16/2023
    Landscape of climate finance in France – 2022 edition

    2022, France is paying dearly for a dependence on fossil fuels maintained by a chronic lack of investment in the decarbonisation of the economy. This edition of the Landscape of climate finance in France makes a detailed analysis of these critical expenditures by households, companies and public authorities, in the retrofitting of buildings, the purchase of electric vehicles, and renewable energies, as well as in rail, cycling and urban public transport infrastructures. Encouragingly, climate investments have increased significantly in the past year, driven, among other factors, by favourable regulations and by state support under the recovery plan. But this growth remains fragile, and analysis of several transition scenarios shows that climate investments need to increase further in order to stay on track to carbon neutrality and to ensure a lasting reduction in France’s dependence on fossil fuels.

See all publications
Press contact Amélie FRITZ Head of Communication and press relations Email
Subscribe to our mailing list :
I register !
Subscribe to our newsletter
Once a week, receive all the information on climate economics
I register !