Climate-Related Risk refers to the potential negative impacts of Climate Change on an organization. In Risk Management context climate-related risks form a collection of fundamental risk factors or underlying causes which are expressed (realised) as more specific risks
Climate-related risks exist in any case and must be managed irrespectively of the causes of climate change. In connection with human induced climate change they form (over the longer term) a more complex system
- risks related to the transition to a lower-carbon economy and
- risks related to the physical impacts of climate change.
In recent years, an increasing number of supervisors have increased their focus on how climate change can translate into financial risks for the financial sector. Financial institutions are exposed to the physical risks of climate change, as they may incur severe losses caused by weather events. Furthermore, the financial industry faces risks in relation to the transition to a carbon-neutral economy, due to considerable exposures to high-emission sectors. These exposures make them vulnerable to new climate policies, rapidly advancing carbon-neutral technology and changing market conditions. It is important that banks be aware of climate-related risks.
A growing number of supervisors therefore expect banks to address the prudential risks from climate change through their existing risk management frameworks. Some supervisors are taking steps to embed climate-related risks in the supervisory approach (SREP). For the supervisory review submission in 2019 in one jurisdiction, non-significant national banks and asset managers were asked to submit their own risk assessment on how climate-related risks affect their exposures and how they monitor and manage these risks. Banks were asked to self-report on four thematic areas that represent core elements of how banks operate:
- Governance: banks are asked to report on how climate-related prudential risks are embedded in their sound business and governance arrangements.
- Strategy: The actual and potential impact of climate-related risks on banks’ strategy and financial planning: banks are asked to report on their strategic approach in managing the prudential risks and opportunities from climate change and their long-term view in setting their strategy.
- Risk Management and Measurement: banks are asked to report on how the prudential risks from climate change are addressed through their existing risk management frameworks.
- Financial Disclosure: Climate-related financial disclosures that could promote more informed investment, lending and insurance underwriting decisions: banks are asked to report on their approach for disclosure of prudential risks from climate change.
- TCFD Report, Recommendations of the Task Force on Climate-related Financial Disclosures, 2017
- Basel Committee on Banking Supervision, "Overview of Pillar 2 supervisory review practices and approaches", June 2019