Climate change risk: The next frontier in banking risk management

Abstract

Extreme weather events are becoming more frequent, more intense and, to a certain extent, more predictable, according to global climate research. Over time, the effects of climate change could alter dramatically the environment upon which communities, societies and economic activity depend. Meanwhile, a correlating impact on firms, sectors and geographies could render traditional business models ineffective or obsolete. Rapid developments in environmental, social and governance (ESG) initiatives, and rising stakeholder demand for improved sustainability performance, will require banks to take a more integrated and strategic approach to climate risk management. This paper explores the practicalities of integrating climate-related risks into existing risk management frameworks, strategies and processes. It examines the key components and attributes of an effective climate-risk framework. And it elaborates on some of the unique characteristics and business model adaptations that are needed to incorporate climate-change considerations into decision-making processes, including capital allocation, loan approval, portfolio monitoring and reporting. In this way, business models can become more economically efficient and strategically resilient to climate risk and equipped to deliver long-term sustainability and value creation.