The expected effects of climate change and the decarbonization process, especially if it is disordered, could translate into losses for the economic system that may be passed to the financial system. Given its central position in the economy, the financial system is particularly exposed to these risks. The financial system's role as intermediary for household savings and firm investments potentially places it in the position of amplifying the negative effects of the adverse events associated with climate change and with the energy transition needed for the decarbonization process.
Climate-related financial risks
Climate-related financial risks can be grouped into two main categories: physical risks and transition risks.
Physical risk is connected with the occurrence of those extreme natural phenomena that science attributes to climate change. These phenomena can be chronic, such as progressive changes in temperature and precipitation patterns, or acute, as in the case of natural events with a low probability of occurrence but that, when they do occur, have a significant impact on the regions hit (such as flooding and heat waves).
Transition risk stems from the process of adjustment to new energy production and consumption systems that make it possible to reduce greenhouse gas emissions. The same policies for combating climate change could also prove to be sources of risk, particularly if they are poorly planned and inconsistent. Sudden or unexpected changes in climate policies (such as regulatory restrictions on the use of fossil fuels or other systems that penalize emissions) may catch firms operating in the most exposed sectors unprepared, with potential consequences for their activity and that of connected entities.
Without appropriate monitoring, these risks could make the financial system more vulnerable and further amplify the shocks transmitted between the financial system and the real economy. Such monitoring requires that financial operators provide adequate disclosure on their exposure to such risks (for example, the geographical location of the guarantees or the amount of the loans disbursed to the sectors most exposed to the transition). Without suitable information and analysis methods to assess the exposure and the probability of the adverse events occurring, financial operators may underestimate climate-related risks. This possibility is heightened by the pervasiveness and the correlation of climate-related risks.
