Understanding and Managing Climate-Related Threats within the Financial Sector
The financial sector is gearing up to address the dual challenges of climate and nature risks, as highlighted in the July 2025 edition of OMFIF's Sustainable Policy Institute Journal.
Physical climate risk, driven by extreme weather events, is becoming a central focus in financial sector risk discussions. Efforts are being made to improve financial strategies such as insurance underwriting, data modeling, and stress testing to address these risks.
Nature risk is also gaining prominence alongside climate risk. Sustainable finance taxonomies are being developed to integrate both climate and nature considerations into financial decision-making and risk assessment.
Regulatory developments are actively shaping the landscape. The EU and UK are advancing significant regulatory initiatives on environmental risk management and sustainability disclosures. Notably, the European Banking Authority is set to enforce guidelines demanding banks incorporate climate stress testing and scenario analysis into their risk frameworks by 2026.
Data gaps remain a key obstacle, particularly for banks, in accurately assessing exposure to physical and transition climate risks. Innovative approaches like Sustainable Fitch’s physical risk assessment tools are being deployed to score assets' vulnerability to hazards like flooding and wildfires under various climate scenarios.
Transition finance and geopolitics also frame key discussions. The sector is focusing on mobilizing capital to meet global net-zero targets while navigating trade tensions and market dynamics impacting critical sectors such as steel, minerals, and clean tech.
Lydia Marsden from University College London emphasizes the importance of policy-makers understanding nature risk and the far-reaching implications of ecosystem tipping points across regions and sectors. William Attwell at Sustainable Fitch states that most banks still have a long way to go to provide comprehensive climate-related information increasingly expected by market stakeholders and supervisors.
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 how finance is structured and how climate action is pursued.
Sem Housen and Emily Dahl from the United Nations Environment Programme Finance Initiative argue that the financial sector should turn 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 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.
Isabella Frymoyer, Programme Coordinator, Sustainable Policy Institute at OMFIF, and Linda-Eling Lee from MSCI Sustainability Institute explore some of the worst-case physical risks, while Paul Hiebert from the European Central Bank writes about the potential financial losses from climate shocks.
Isabela Ribeiro Damaso Maia of Banco Central do Brasil highlights options available to financial institutions to support the transition, including adjusting regulatory frameworks, more comprehensive data collection, and stress testing.
Sharon Asaf and Sebastian Werner at Citi consider the relationship between scientific and financial modelling, emphasizing that limitations in scientific models lead to struggles to precisely replicate climate impacts, particularly in the short term.
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- The financial sector is progressively addressing the dual challenges of climate and nature risks, highlighted in the July 2025 edition of OMFIF's Sustainable Policy Institute Journal.
- Physical climate risk, driven by extreme weather events, is central in financial sector risk discussions, with efforts directed towards improving strategies like insurance underwriting, data modeling, and stress testing.
- Nature risk, in conjunction with climate risk, is gaining prominence and sustainable finance taxonomies are developed to integrate both climate and nature considerations into financial decision-making and risk assessment.
- Regulatory developments, such as the European Banking Authority's guidelines for climate stress testing, are actively shaping the financial sector landscape.
- Data gaps present a significant hurdle for banks in accurately assessing exposure to climate risks, with innovative tools like Sustainable Fitch’s physical risk assessment being employed to score asset vulnerability under various climate scenarios.
- Transition finance, geopolitics, and global net-zero targets are key topics of discourse, as the sector works to mobilize capital for critical sectors like steel, minerals, and clean tech, while navigating trade tensions.
- Policy-makers are urged to understand the implications of nature risk and ecosystem tipping points, as well as the persistent mismatch between climate finance structures and action in developing countries.
- Stakeholders expect comprehensive climate-related information from banks, yet most banks still have room for improvement in providing such information, as stated by William Attwell at Sustainable Fitch.
- As the financial industry transitions to net zero, understanding the risk associated with environmental impacts will remain crucial to mitigating financial system stress, with options available such as adjusting regulatory frameworks, comprehensive data collection, and stress testing.
