Climate Risk

Climate risk is usually divided into two main types. Physical risk comes from climate-related events and long-term changes, such as floods, storms, wildfires, droughts, heatwaves and rising sea levels. Transition risk comes from changes in policy, technology, markets and consumer preferences as economies shift away from fossil fuels.

Some frameworks also include liability risk, from legal claims against companies or governments for contributing to climate change or failing to disclose climate risks.

For example, a bank lending to coastal property developers faces physical risk from flooding, while a bank lending to coal mining companies faces transition risk if stricter emissions rules reduce demand for coal.

Climate risk has become a major focus for regulators, central banks and investors. Many jurisdictions now require or encourage companies and financial institutions to assess and disclose their climate risks, using frameworks such as the recommendations of the Task Force on Climate-related Financial Disclosures and the ISSB standards. Central banks run climate stress tests to assess the financial system’s resilience.