Climate Risk Market Influences
Risk Potential effects of climate risk drivers (TCFD defines risk into two categories: physical and transition risks)
Credit risk Credit risk increases if climate risk drivers reduce borrowers’ ability to repay and service debt (credit exposure) or banks’ ability to fully recover the value of a loan in the event of default Market risk Reduction in financial asset values, including the potential to trigger large, sudden and negative price adjustments where climate risk is not yet incorporated into prices.
Climate risk could also lead to a breakdown in correlations between assets or a change in market liquidity for assets, undermining risk management assumptions. Liquidity risk Banks’ access to stable sources of funding could be reduced as market conditions change.
Climate risk drivers may cause banks’ counterparties to draw down deposits and credit lines. Operational risk Increasing legal and regulatory compliance risk associated with climate-sensitive investments and businesses. Reputational risk Increasing reputational risk to banks based on changing market or consumer sentiment.
Banks’ business models and exposures can increase the severity of any climate-related risk impact. This is because certain economic sectors will have greater sensitivities to acute climaterelated physical risks or to the transition to a low carbon economy;