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BFSI Chronicle, 11 Edition September2022
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Climate Change Risks for Banks risk. That requires integration across the entire risk
The stakes of climate change are high for many management framework.
industries: physical risks are beginning to materialize,
regulatory pressures are increasing, new opportunities Historically, banks have approached climate change
are emerging – and investors are demanding more through the lens of Corporate Social Responsibility
transparency. The first step is understanding what, (CSR). With increasingly high financial stakes,
exactly, is at risk. growing external pressures, and new regulations, the
pure CSR approach is no longer sufficient. Climate
Financial risks: There is a growing consensus among change has become a financial risk for banks and
policymakers and supervisors that climate change must be treated as such. Banks need to quantify
poses real financial risks. Evidence is building that climate factors across the business and put in place
transition and physical risks arising from climate the tools and processes needed to take advantage of
change represent a material risk to the banking them effectively. At the same time, they must ensure
system and may even be a source of systemic risk to that their operations are aligned with the demands of
the financial system. external stakeholders. The commercial imperatives for
better climate-risk management are also increasing.
Physical risks: cover those that impact the premises In a competitive environment in which banks are
and operations of the bank, its customers, and the often judged on their green credentials, it makes
wider economy. They include extreme weather events sense to develop sustainable-finance offerings and
and long-term shifts in climate leading to the closing to incorporate climate factors into capital allocations,
of retail branches or facilities, negatively impacting loan approvals, portfolio monitoring, and reporting.
the creditworthiness of clients, and adversely Some banks have already made significant strategic
affecting asset prices. decisions, ramping up sustainable finance, offering
discounts for green lending, and mobilizing new
Transition risks: cover those that impact a bank’s capital for environmental initiatives. Following
products and services as a result of the move toward approaches will support this transformation.
a lower carbon economy. They include the extent to
which a bank funds or has stakes in companies that Build the foundations: Banks should urgently identify
emit greenhouse gases (GHGs), evolving stakeholder the processes, methodologies, and tools they will
expectations, and associated legal or regulatory need to manage climate risk effectively. This entails
changes. embedding climate factors into risk and credit
frameworks.
Managing Climate Risk
The impact of climate change over time will force Formulate climate-risk governance: It will be of
major structural adjustments to the global economy crucial importance for top management to set the tone
that will inevitably affect banks’ operations and on climate-risk governance. Banks should nominate a
balance sheets. Responding to climate change will leader responsible for climate risk; chief risk officers
affect the business of a bank in its entirety: deciding (CROs) are often preferred candidates. There is also
which clients to lend to in the future, assessing a cultural imperative: responsibility for climate-risk
which businesses to support through investments, management must be cascaded throughout the
determining what type of financial instruments to organization.
offer and even deciding how to remunerate staff. A
business strategy that addresses climate risk will have Consider all the what- Ifs : Analysing the potential
real impacts. With all of these forces bearing down impacts of both physical risk and transition risk
on banks, their leaders need to adopt comprehensive, is critical for planning. Climate scenario analysis,
firm-wide approaches to managing climate change essentially a “what-if” analysis, is a useful method

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