Managing climate-related risks in financial organizations
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In the July 2025 edition of OMFIF's Sustainable Policy Institute Journal, the focus is on how the financial sector is addressing climate risk, with a central theme of managing physical and transition risks through strengthened regulatory frameworks and data improvements.
Physical Climate Risks: A Growing Concern
Financial institutions are increasingly focusing on physical climate risks, driven by extreme weather events. They are enhancing insurance underwriting, improving data modeling and stress testing, and optimizing capital allocation to support climate adaptation efforts. Tools like Sustainable Fitch’s physical risk assessments, which quantify exposure of assets to hazards such as floods and wildfires under different warming scenarios, are gaining prominence to better gauge and price these risks.
Regulatory Pressure: Recalibration, Not Retreat
Regulatory pressure remains strong, but it is undergoing recalibration rather than retreat. The European Union is reviewing the timing of sustainability regulation, maintaining robust ambitions through measures like the European Banking Authority’s environmental risk guidelines. These guidelines demand scenario analyses and the integration of climate into credit, market, and operational risk frameworks, starting in 2026. The UK is advancing high standards on climate risk management, adopting International Sustainability Standards Board reporting requirements and the Bank of England’s elevated expectations from firms for forward-looking climate risk disclosures and governance.
Transition Risks: Shifting to a Low-Carbon Economy
Transition risks—the risks associated with shifting to a low-carbon economy—are being assessed mainly via banks' lending exposures to carbon-intensive sectors. Studies of bank portfolios show persistent exposures to sectors like coal, oil, gas, and heavy industry, highlighting ongoing regulatory and market pressures to decarbonize. This underscores the need for banks to improve environmental business activity ratings and strategically adjust their portfolios.
Data Gaps: A Significant Hurdle
Despite improvements, data gaps remain a significant hurdle for effectively managing climate risks. Improved disclosure requirements and harmonized standards are underway, but banks and financial institutions continue to face challenges in acquiring comprehensive, high-quality climate risk data.
The Road Ahead: Opportunities and Challenges
The financial sector's current climate risk approach involves integrating enhanced physical risk analytics, adapting to evolving but robust regulatory frameworks, addressing transition risk exposure in portfolios, and overcoming data limitations to support resilience and sustainable finance. As the industry continues to grapple with climate risks, it is essential to understand the risk associated with environmental impacts, particularly as the financial industry transitions to net zero.
A Call for Action: Nature Risk and Net-Zero Transition
Experts like Lydia Marsden from University College London emphasize the need for policy-makers to better understand nature risk, as ecosystem tipping points have far-reaching implications across regions and sectors. No advertisements were extracted from the current paragraph. Sem Housen and Emily Dahl from the United Nations Environment Programme Finance Initiative argue that the financial sector is responsible for turning away from nature-negative flows towards activities that mitigate climate change and build resilience. Marcus Pratsch from DZ BANK writes that nature-positive solutions must remain central to the net-zero transition as the importance of biodiversity in capital markets is increased.
Understanding Climate Impacts: Scientific and Financial Modelling
Understanding the risk associated with environmental impacts, particularly as the financial industry transitions to net zero, will remain essential to easing stress on the global financial system. Sharon Asaf and Sebastian Werner at Citi consider the relationship between scientific and financial modelling, emphasizing limitations in scientific models lead to struggles to precisely replicate climate impacts, particularly in the short term.
Climate Finance: Challenges for Developing Countries
Climate shocks, stemming from physical and transition risk, could lead to immeasurable financial loss. Udaibir Das from the National Council of Applied Economic Research states that the most serious constraint on climate finance for developing countries is a persistent mismatch between finance structure and climate action. The Sustainable Policy Institute at OMFIF is interested in this topic.
In conclusion, the financial sector is making strides in addressing climate risks, but there is still a long way to go. As the industry continues to evolve, it will be crucial to address data gaps, adapt to regulatory changes, and strategically manage transition risks to support a sustainable and resilient financial system.
- Financial institutions are focusing on physical climate risks, including extreme weather events, and are using improved data modeling, stress testing, and capital allocation to support climate adaptation efforts.
- The European Union is reviewing the timing of sustainability regulation and maintaining robust ambitions with measures like the European Banking Authority’s environmental risk guidelines, which demand scenario analyses and the integration of climate into risk frameworks.
- Transition risks, associated with shifting to a low-carbon economy, are being assessed via banks' lending exposures to carbon-intensive sectors, and it is necessary for banks to improve environmental business activity ratings and strategically adjust their portfolios.
- Despite improvements, data gaps remain a challenge in effectively managing climate risks, and banks continue to face challenges in acquiring comprehensive, high-quality climate risk data.
- The financial sector's approach to climate risk involves integrating enhanced physical risk analytics, adapting to evolving but robust regulatory frameworks, addressing transition risk exposure in portfolios, and overcoming data limitations to support resilience and sustainable finance.
- Experts argue that policy-makers need to better understand nature risk, as ecosystem tipping points have far-reaching implications across regions and sectors, and the financial sector should turn away from nature-negative flows towards activities that mitigate climate change and build resilience.
- Understanding the risk associated with environmental impacts, particularly as the financial industry transitions to net zero, will remain essential to easing stress on the global financial system, and there is a need to consider the relationship between scientific and financial modeling.
- Climate shocks could lead to financial loss for developing countries, and the most serious constraint on climate finance for these countries is a persistent mismatch between finance structure and climate action.
- As the financial sector continues to address climate risks, it will be essential to understand the risk associated with environmental impacts, particularly as the industry transitions to net zero, and to address data gaps, adapt to regulatory changes, and strategically manage transition risks to support a sustainable and resilient financial system.
