Key Impact Points:
- Banks need to understand and integrate physical climate risks into their portfolio assessments.
- Climate risks will intensify, significantly impacting vulnerable regions and sectors.
- There are robust strategies banks can employ to quantify and mitigate these risks, creating business opportunities.
A new report by Andrea Castoldi, Giovanni Lucini, Bruno Micale, Amine Benayad, and Matteo Coppola from the Boston Consulting Group (BCG) highlights the urgent need for banks to address physical climate risks. The white paper, titled “How Banks Can Transform Physical Climate Risk into an Opportunity,” provides a comprehensive guide on how banks can not only mitigate these risks but also turn them into profitable opportunities.
As climate-driven natural disasters become more frequent and severe, it is imperative for banks to understand and integrate physical climate risks into their portfolio assessments. This white paper outlines how banks can turn these risks into opportunities.
Escalating Climate Events
Climate perils are becoming real events. In 2022, drought severely impacted 2.2 million hectares of farmland in China. In February 2024, temperatures in the Southern Cone of Africa were 4°C to 5°C above the seasonal average, causing school closures and halting productivity. These events join wildfires in the US and Chile, floods in Afghanistan and Pakistan, typhoons in the Philippines, and heat waves in India and Japan. In 2023, floods disrupted Italy’s fruit harvest, resulting in losses of about $9.5 billion, with only $0.5 billion covered by insurance.
Intensifying Climate Risks
The IPCC warns that if current climate policies remain unchanged, global temperatures could rise by 2.1°C to 3.6°C by 2050. This increase will trigger severe economic impacts, especially in vulnerable regions, leading to migrations, political instability, and environmental stress. For example, the Southern Cone of Africa could see a temperature rise of 4°C by 2100, increasing ocean levels by 100 cm, drought frequency by nine times, and extreme weather events by 30%.
Necessity for Banks
“Acting now on physical risk is an imperative for banks,” state the authors. Banks must integrate these risks into their risk assessments and support clients in financing adaptation and resilience measures. European bank loan portfolios, representing $2.9 trillion, are already exposed to physical climate risks. The European Central Bank requires banks to measure and integrate these impacts into their risk management frameworks and business strategies.
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Geographical Vulnerabilities
Climate change disproportionately affects specific regions. Coastal areas face heightened risks of flooding and storms. Africa, Asia, and small islands suffer most from agriculture, fisheries, and infrastructure damage. Unexpected events, like Germany’s $40 billion flash flood damage in 2021, underscore the need for robust risk assessments even in typically low-risk regions.
Building Robust Quantification Approaches
Banks need a robust science-based approach to quantify physical risks, focusing on exposure, hazards, vulnerability, and economic impact. Key steps include identifying asset locations, acquiring hazard data, and translating this data into comparable scores. This helps in understanding the impact on portfolios and supporting clients’ resilience measures.
Creating Business Opportunities
By integrating physical-risk assessments, banks can create new business opportunities. Financing adaptation and resilience measures for clients can generate significant business in the short and medium term. The focus should be on supporting clients in high-risk sectors and regions, helping them mitigate and adapt to climate impacts.
The European Central Bank mandates that banks “measure the impact of physical hazards alongside that of transition hazards.”
By taking proactive steps, banks can not only mitigate risks but also drive positive societal impact and secure long-term profitability.
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