Analysis

Climate Impact on Finance

How physical climate change and the transition to a low-carbon economy are reshaping investment risk, asset values, and the structure of financial systems.

Satellite view of city floodplain illustrating physical climate risk to infrastructure

The Financial System and Climate Risk

Climate change is no longer a distant environmental concern — it is an active and accelerating source of financial risk. Central banks, regulators, and institutional investors have spent the past decade building frameworks to understand, measure, and manage this risk.

The financial implications operate through two primary channels: physical risk — the direct economic damage caused by extreme weather, sea-level rise, and ecosystem disruption — and transition risk — the economic disruption arising from the policy, technology, and market shifts required to limit warming.

Understanding both channels is essential for assessing the long-term value of assets, the stability of financial institutions, and the allocation of capital across the economy.

Estimated economic losses from weather events (2023)

$380B

22% above 10-yr average

Assets potentially stranded in high-carbon sectors by 2030

$1–2T

Various scenario estimates

Central banks with climate risk in mandate/practice

90+

NGFS member institutions (2024)

Flooding in coastal city representing physical climate risk

Physical Risk

Direct Financial Damage from Climate Events

Physical climate risks manifest as acute events — floods, wildfires, hurricanes — and chronic shifts such as sea-level rise, sustained heat, and changing precipitation patterns. Both have direct financial consequences: property damage, infrastructure degradation, agricultural losses, and higher insurance costs.

Real estate is among the most exposed asset classes. Properties in flood zones, wildfire interfaces, or coastal areas facing inundation risk are seeing early signs of repricing in some markets. Insurance availability is also declining in high-risk areas — a dynamic that can trigger rapid value loss and create systemic risks for mortgage lenders.

Global insured losses from natural catastrophes reached $100B+ for the fourth consecutive year in 2023
Insurance protection gap (uninsured vs insured losses) remains approximately 60% globally
Agricultural commodity price volatility is increasingly linked to weather extremes
Infrastructure repair costs from climate events are shifting fiscal positions of sovereign issuers

Electric vehicle charging station as a symbol of economic transition

Transition Risk

Economic Disruption from Decarbonisation

The transition to a low-carbon economy involves rapid structural change across energy, transport, industry, and agriculture. This creates transition risks: the possibility that carbon-intensive assets become stranded, that regulatory changes increase costs for high-emitting businesses, and that technology shifts disrupt existing value chains.

Stranded assets — particularly fossil fuel reserves and infrastructure that may not generate expected returns due to climate policy — represent a potential source of financial instability if the transition is abrupt or disorderly. The NGFS scenarios model a spectrum from orderly to disorderly to delayed transitions, each with different financial risk profiles.

Carbon pricing mechanisms now cover approximately 23% of global greenhouse gas emissions
EU Carbon Border Adjustment Mechanism (CBAM) creating new trade-related financial risks
Electric vehicle adoption accelerating faster than many financial models assumed
Fossil fuel demand uncertainty increasing the cost of capital for new extraction projects

Regulatory Response

How Regulators Are Responding

Financial regulators globally are incorporating climate risk into supervisory frameworks, stress testing, and disclosure requirements.

Climate Stress Testing

Major central banks — the Bank of England, ECB, Banque de France, and others — have conducted climate stress tests of banking and insurance sectors. Results generally show manageable near-term impacts but significant long-run exposure under disorderly transition scenarios.

Mandatory Disclosure

The EU's CSRD, ISSB standards, and the SEC's climate disclosure rule (subject to ongoing legal challenges as of 2024) are expanding requirements for companies to disclose climate-related risks and their potential financial impacts.

Green Taxonomy

The EU Taxonomy Regulation provides a classification system for environmentally sustainable economic activities, creating a reference point for financial products and corporate disclosures. Other jurisdictions are developing comparable frameworks.

Carbon Pricing

Emissions trading systems (EU ETS, UK ETS, California-Quebec) and carbon taxes create direct financial incentives to reduce emissions. Price volatility in carbon markets creates both risks and opportunities for financial market participants.

Prudential Rules

Regulators are considering whether to adjust capital requirements for climate-exposed assets — either through a "brown penalising factor" for high-carbon assets or a "green supporting factor" for low-carbon assets — though this remains debated.

NGFS Network

The Network for Greening the Financial System (NGFS) brings together 130+ central banks and supervisors to coordinate on climate risk assessment. It produces widely-used climate scenarios and guidance on supervisory approaches.

Scenario Analysis

NGFS Climate Scenarios — Overview

NGFS scenarios are widely used in climate stress testing and portfolio analysis. This table summarises the main scenario types.

Scenario	Temperature Pathway	Transition Risk	Physical Risk	Key Characteristics
Net Zero 2050	1.5°C	High	Low	Strong, early, well-managed policy action. Most disruptive to carbon-intensive sectors.
Delayed Transition	~1.8°C	Very High	Medium	Late, abrupt policy action. Higher transition risk due to compressed timeline. Most financially disruptive.
Divergent Net Zero	1.5°C	High	Low	Different policy pathways across sectors/regions, leading to higher near-term costs and inefficiencies.
NDC Scenario	~2.5°C	Medium	High	Countries meet current NDCs but no stronger action. Significant physical risk accumulates.
Current Policies	>3°C	Low	Very High	No new climate policy. Highest long-run physical damage and financial instability.

Source: NGFS Climate Scenarios for Central Banks and Supervisors (Phase IV). Figures and categorisations are approximate and simplified for informational purposes.

Sector Exposure

High-Exposure Sectors and Asset Classes

Fossil Fuel Extraction

Coal, oil, and gas producers face the most direct transition risk. Proven reserves may not be economically recoverable under stringent climate scenarios. Long-lived infrastructure poses stranded asset risk.

Real Estate

Coastal, low-lying, and fire-prone properties face physical risk from flooding and wildfire. Energy performance regulations are also creating transition risk for inefficient buildings.

Heavy Industry

Steel, cement, aluminium, and chemicals face transition risk from carbon pricing and energy costs. Decarbonisation requires capital-intensive process changes with uncertain economics at scale.

Aviation & Shipping

Long-haul aviation and international shipping are hard-to-abate sectors. Regulatory pressure (EU ETS extension to aviation, IMO decarbonisation targets) is increasing operating costs and creating demand for sustainable fuels.

Agriculture

Physical risk from changing precipitation, heat stress, and drought threatens crop yields and supply chains. Agricultural land value is also exposed to both physical and nature-related regulatory risks.

Utilities

Power utilities face both physical risk (infrastructure damage, water scarcity for cooling) and significant transition opportunity. The pace of grid decarbonisation creates capital allocation and regulatory risk.