Climate Risk

What is Climate Risk?

Climate risk refers to the potential financial impact of climate change-related events on businesses and economies. It encompasses physical risks such as extreme weather events, transition risks associated with shifts towards a low-carbon economy, and liability risks stemming from legal and regulatory changes. Understanding climate risk is essential for financial institutions as it can significantly affect their profitability, stability, and long-term viability.

With climate change becoming increasingly pronounced, it has emerged as a significant risk factor for financial institutions worldwide. The frequency and severity of extreme weather events, regulatory changes aimed at mitigating climate change, and shifting consumer preferences towards sustainable investments all contribute to the growing importance of climate risk in financial risk management.

Why is Climate Risk Management important for Financial Institutions?

Financial institutions face multifaceted risks from climate change, including exposure to carbon-intensive industries and collateralized assets vulnerable to extreme weather events.
Effective management of climate risk is vital for safeguarding financial stability and resilience.
International agreements like the Paris Agreement and the European Green Deal shape regulatory frameworks, driving reforms and incentivizing sustainable investments.
Regulatory bodies scrutinize financial institutions’ climate risk exposure, necessitating assessment and mitigation across various risk categories.
Financial institutions play a crucial role in financing the transition to a low-carbon economy, requiring proactive measures and collaboration with stakeholders to manage climate risk effectively.

Why Choose Probability & Partners?

Probability & Partners offers tailored solutions in climate risk management, leveraging expertise in the Dutch financial sector, quantitative modeling, and stress testing.
We provide actionable insights and strategic guidance, positioning ourselves as a trusted partner in climate risk management.
Partnering with experienced consultants like Probability & Partners is crucial for financial institutions to navigate climate risk challenges effectively, ensuring long-term sustainability and success.

Our Approach

Framework for Managing Climate Related Risks

Real World Climate Events: Actual climate events that provide data and insights for risk assessment and model validation.
External Climate Scenarios: Hypothetical scenarios used to assess potential future climate risks.
Regulations: The regulatory requirements that govern the management of climate risks in financial institutions. This can shape the entire process of risk management.
Initial Strategic Risk Assessment: Financial institutions start by assessing the potential impact of climate-related risks on different areas of their operations. These areas include:
- Market Risk: Impact on market prices and the value of investments due to climate events.
- Credit Risk: The risk that borrowers may fail to repay loans due to the financial effects of climate events.
- Liquidity Risk: Risks related to the institution’s ability to meet its financial obligations during and after climate events.
- Operational Risk: The potential for climate events to disrupt business operations.
- Reputational Risk: The risk of damage to the institution’s reputation due to its handling or association with climate issues.
- Underwriting Risk: Risks associated with insuring assets against climate events.
- Strategic Risk: Long-term risks to the business strategy due to climate change.
- Interest Rate Risk: The risk of interest rate fluctuations affected by climate change policies or events.
Modeling / Stress Testing: This step involves developing models to predict the impact of climate events and running stress tests under various external climate scenarios to assess resilience and preparedness.
1. Concept: The initial ideas and assumptions for the climate risk models.
2. Data Management: Handling the relevant data required for modeling climate risks.
3. Methodology: The specific techniques and approaches used to model climate risks.
4. Model Validation: The process of ensuring that the climate risk models are robust and reliable.
5. Model Implementation: Putting the validated models into practice to assess climate risks.
6. Result / Reporting: After modeling and stress testing, the institution reports the results, which include the climate risk adjusted risk profile – a summary of the institution’s risk exposure after taking climate factors into account.
Final Risk Assessment: Taking into account the results from stress testing and reporting, the institution conducts a final assessment of risks, adjusting their risk profiles for climate factors.
Business Model Adaptation: Based on the final risk assessment, the institution may need to adapt its business model. This could include changes to
- Pricing / Origination: Changing pricing strategies for financial products or services due to climate risk factors.
- Governance: Updating governance structures to ensure adequate oversight and management of climate risks.
- Climate Risk Watch Tower: Creating an oversight function within the financial institution’s climate risk management framework.
- Risk Appetite Statement: Revising the level of risk the institution is willing to accept in light of climate risks.
- Market Segmentation: Adjusting market strategies to account for climate risk.
Damage Control and Recovery:
- Despite proactive measures, financial institutions may encounter climate-related disruptions, necessitating robust contingency plans and scenario analysis.
- Mitigating climate risk involves implementing clear protocols for adaptation and minimizing losses, alongside stress testing to evaluate vulnerabilities and readiness.

Insights

From Climate to Nature New biodiversity requirements for financial institutions

September 24, 2024

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Pim Poppe

Managing Partner

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Gerd-Jan van Wiggen

Sector Lead Banking

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Climate Risk

What is Climate Risk?

Why is Climate Risk Management important for Financial Institutions?

Why Choose Probability & Partners?

Our Approach

Framework for Managing Climate Related Risks

Insights

From Climate to Nature: New biodiversity requirements for financial institutions

Maurits van den Oever: De sector moet aan de slag met biodiversiteit en regelgeving

Emre Erkan & Svetlana Borovkova: Establishing a climate stress testing framework in banks

Svetlana Borovkova: Climate stress testing – where to start?

Svetlana Borovkova: Climate risk – what are the opportunities for investors?

Pim Poppe: Klimaatverandering, voorkomen of aanpassen?

Amba Zeggen: Zomerlectuur voor de herfst

Svetlana Borovkova: Scenarios for climate risk

Svetlana Borovkova: Climate risk: a new investment fundamental?

Pim Poppe: Inspiratie van de ECB-klimaatstresstest

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Pim Poppe

Gerd-Jan van Wiggen

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