"What's the use of a fine house if you haven't got a tolerable planet to live inside."

Climate Risk is the most challenging problem today, more severe than terrorism. A nation that destroys its soils destroys itself. Forests are the lungs of the motherland, purifying the air and giving fresh strength to the people. Changes in the weather do not cause climate change; changes in our lifestyles do. Increased temperature and precipitation patterns evolve out of energy-intensive polluting industries around the globe, causing greenhouse gas emissions. Pollution creates low crop yields, food shortages, and higher prices. Excess heat increases the frequency and severity of natural disasters like floods, hurricanes, wildfires, and droughts. The turbulence damages property and infrastructure, disrupting supply chains and losing human life.

Unfortunately, banks are not playing the role that they must play to stop the menace of climate risk. If bankers continue to finance polluting units, the posterity will brand them as opportunists working narrowly for profits ignoring the larger picture of sustaining the Earth as a better place to live.

Climate risk significantly impacts individuals, organisations, and society: The frequency and severity of natural disasters lead to increased insurance claims and payouts, affecting insurance companies’ profitability. As a result, premiums rise, making it more difficult for all to obtain insurance coverage.

Climate risk adversely affects the financial markets: As investors become increasingly aware of the risks associated with climate change, they divest from companies seen as contributing to climate change or particularly vulnerable to its effects.

Climate risk adversely affects the agricultural markets: In the farm sector, extreme weather events such as droughts and floods cause significant damage to crops and infrastructure, leading to lower yields and higher costs for farmers. 

Climate risk impacts credit risk and the credit risk assessment process: Credit risk refers to the risk that a borrower will default on a loan or debt obligation. Climate change can affect credit risk through physical risks like damage to property and infrastructure due to extreme weather events. If a borrower's infrastructure is damaged, he may be less able to repay their loans, which could increase the default.

Another way that climate change can affect credit risk is through transition risks. These risks refer to the potential financial impacts of transitioning to a low-carbon economy, such as regulatory changes, shifts in consumer preferences, and technological advancements. Suppose a borrower's business model depends on activities that contribute to climate change, such as the use of fossil fuels; in that case, they may face significant financial risks as the world transitions to a low-carbon economy.

To assess credit risk in the context of climate change, lenders and credit-rating agencies must incorporate climate risk analysis into credit assessments, developing new metrics and models to measure climate risk through transparent climate-related data and disclosures.

Climate risk significantly impacts financial markets and asset prices, leading to real estate and energy market disruptions. As the world transitions to a low-carbon economy, companies face substantial financial risks due to changes in regulations, consumer preferences, and technological advancements. Companies that rely heavily on fossil fuels find their valuations decline due to stiff carbon pricing and emission regulations. Conversely, companies focused on renewable energy and energy efficiency may see their valuations increase.

Climate Risk leads to reputational risks for companies. As investors become increasingly aware of the risks associated with climate change, they may avoid companies seen as contributing to the problem or not taking sufficient action to address it.

Climate risk can significantly impact operational risk and the likelihood of business operational failures. Operational risk is loss from inadequate or failed internal processes, people, systems, or external events. A company's manufacturing plant could be damaged by flooding or a wildfire, leading to a loss of production, delays in product delivery and a loss of revenue. It could be forced-closed for non-observance of ESG norms. These risks lead to operational failures if companies cannot adapt to the changing regulatory environment and transition to a low-carbon business model. To mitigate the risks of climate change on operational risk, companies must invest in infrastructure and technologies that are resilient to the impacts of climate change.

Climate risk can significantly impact liquidity risk, which refers to the risk of a sudden and unexpected liquidity shortage or the ability to meet short-term financial obligations. The climatic disruptions lead to a decline in revenue and cash flow, which could impact a company's ability to meet short-term financial obligations.

Risk Management Framework of Banks 

Banks have developed a comprehensive Rating matrix to measure the risk of various categories of clients. Most parameters measure Credit risk, some Market Risk and others Operational risk. The only reference to climate risk happens while seeking a NOC from the Pollution Control Board. There needs to be cross-checking as most borrowers arrange such certificates through questionable means. The Risk Management Framework of Banks needs a solid overhaul to encompass all facets of climate risk enveloping the fauna and flora in its vice grip. 

Here are six strategies for addressing climate risk in risk management frameworks:

Incorporate climate risk into risk assessment frameworks: Climate risk should be integrated into traditional risk assessment frameworks to ensure that all physical, transitional, and reputational risks are identified, evaluated, and managed appropriately.

Develop a climate risk management strategy: A climate risk management strategy sets out the company's approach to managing climate risks. This strategy should include mitigation measures, such as reducing greenhouse gas emissions and transitioning to a low-carbon economy, as well as adaptation measures, such as investing in infrastructure that is more resilient to the impacts of climate change.

Conduct stress tests: Stress tests are required to assess the potential impacts of climate risk on the company's operations, financial performance, and solvency. The verification can help identify potential vulnerabilities and inform risk management strategies.

Diversify investments: Diversifying investments can help reduce exposure to climate risk by spreading investments across different sectors and asset classes. The step can minimize the impact of climate risk on overall portfolio performance.

Engage with stakeholders: Engaging with stakeholders, including investors, regulators, customers, and communities, can help companies better understand and manage climate risk. The measure can help build stakeholder trust and credibility, ultimately contributing to long-term sustainability.

Monitor and report on climate risk: Companies should monitor and report on climate risk to ensure that risk management strategies are practical and to provide transparency to stakeholders. The step can help build trust and credibility with investors and other stakeholders and contribute to long-term sustainability.

As the frequency and severity of natural disasters increase, society will need to mitigate the impacts of climate change. Climate change can slow down if we collectively rethink our consumption practices.

Banks should work towards reducing carbon footprints on the Earth and its resources by gatekeeping on the polluting industries trying to enter bank books. Let the public not be punished by pollution generated by initiatives funded by their money.

Rightly says Jim Yong Kim, "We will never end poverty if we don't tackle climate change through diligent management of climate risk."

Mr. Hargovind Sachdev has over 39 years of banking experience having occupied senior positions in UCO Bank, United Bank of India, State Bank of Patiala, State Bank of Travancore & State Bank of India where he headed the Central European Credit Desk at Frankfurt, Germany from 2006 to 2011 covering 15 countries of Central Europe.