The author of this article argues that adapting to climate change and its effects is not just about managing risk, but a large business opportunity.

This article is from Lukky Ahmed, CEO and co-founder at Climate X, a firm based in London and New York that provides actionable intelligence on climate risk and data enabling clients to adapt rapidly. It covers sectors such as banking, real estate, insurance and resources. 

Hurricanes, floods and drought are some of the phenomena that are, according to many, being made more severe by human-caused global warming. Given the impact on insurance premiums, cash-flow and hits to companies’ revenues, the risks associated with climate are ones that banks need to bear in mind. To add colour and detail to this conversation, Ahmed seeks to explain the relevance of this topic to banks, and how they should address it. The editors of this news service are pleased to share these views; the usual editorial caveats apply. If you wish to jump into the conversation, please do so! Email tom.burroughes@wealthbriefing.com and amanda.cheesley@clearviewpublishing.com

Extreme weather events are an ever-present in global news cycles at the moment, with Hurricanes Helene and Milton reminding us all of the devastating impact of climate change. For financial institutions and investors, the growing frequency and severity of such events underscore a critical risk: climate change has the power to destabilize regions, damage economic output, influence policy, and directly impact asset portfolios.

Extreme weather events can significantly impair the ability of thousands of borrowers to generate income – and damage the physical assets they use as collateral, resulting in higher default probabilities and higher loss-given defaults.

Not only that, but there is mounting regulatory pressure for transparent climate-related disclosures, with the potential for financial and reputational repercussions if they fail to comply.
 
The challenges of climate modeling
Integrating climate considerations into financial decision-making is essential for long-term institutional resilience and profitability. However, banks, investors and regulators are all still finding their way in the nascent physical climate risk and adaptation space.

Translating complex scientific climate evidence into financial risk is challenging, and assessing financial risk management to support decision-making processes is complex. Many organizations have yet to integrate physical climate risk into mainstream risk management processes. And all institutions are finding it challenging to accurately assess risks from a portfolio-wide perspective. According to our recent report, 88 per cent of the top global commercial banks are not adequately addressing climate adaptation risks.
 
Not only is climate modeling complex, but it’s also a constantly evolving field. While modeling technology is advancing rapidly, it’s hard to know whose model to trust when different data providers deliver markedly different assessments for the same hazards/scenarios applied to the same locations.

From a policy perspective, regulators face the challenge of pushing for enhanced climate risk disclosures with organizations that are understandably keen to protect their IP. It’s a balancing act, and it will take time and collaboration to get right.

Ultimately, banks and regulators need to align on their best view of risk based on the climate models that prove most defensible, also difficult given that, self-evidently, no model can be truly validated based on an inherently uncertain future.

Strong governance sets the climate adaptation leaders apart
While global initiatives such as IFRS S2 are setting the regulatory benchmark for climate-related disclosures, financial institutions have a vested interest in pushing beyond minimal compliance requirements.

They need to establish strong climate model governance standards and risk management capabilities that will allow them to trust in the interoperability of risk and modelling data from different internal and external sources, and gain confidence in their climate-related decision-making.

Having the right infrastructure in place now will have an added benefit for the near future; it will make it significantly easier for banking leaders to calibrate their organizations around climate adaptation, which is a subject we explore in our latest report, Climate Risk for the Banking Industry.

The business case for climate adaptation
Climate adaptation is not just about managing risks – it is also about seizing a substantial business opportunity. There’s the potential to capture $26 trillion in green opportunities and support the creation of 65 million new jobs by 2030, to design new products and services to meet customers’ needs such as financing resiliency projects, all whilst developing leaner, more resilient business models to forge ahead of the competition.

With proactive climate adaptation, financial institutions can move beyond regulatory compliance and create lasting trust and value for customers as the world inevitably adapts to the increased prevalence – and threat – of extreme weather.