Section 3 – Getting started with climate risk management

Getting started with climate risk management

Climate risk includes two closely linked elements (see Section 2): physical risks from short-term extreme events and long-term climate changes, and transition risks from policy, market, technology and legal changes linked to a low-carbon economy. Both can have major financial impacts on revenues, costs, asset values and access to capital. Embedding climate risk management into operations is therefore essential for maintaining resilience, meeting regulatory expectations and capturing new opportunities.

The business case for climate risk management

• Climate risk is both a regulatory requirement and a financial reality
  Climate risk is now recognised as a core financial consideration that impacts credit quality, asset values and business continuity. Physical risks such as extreme weather are already causing financial shocks such as loan defaults, collateral impairment and operational disruption. Transition risks, including new emissions standards, carbon pricing and changing investor expectations, are reshaping markets and access to markets.

  • Financial authorities around the world are defining climate risk management as a regulatory priority. For emerging market banks, this is a pressing concern.
  • Across Africa, Asia and Latin America, regulators are introducing mandatory climate risk disclosures, scenario analysis frameworks and stress testing guidelines. Central banks in countries such as Kenya, Malaysia, Bangladesh and India are leading similar efforts, embedding climate considerations within financial regulation.
  • Institutions that take early action on climate risks will be better placed to meet evolving expectations, protect credit quality and maintain access to capital.

• Climate risks amplify traditional financial risk drivers
  As this toolkit demonstrates, climate risk management can become an extension of existing financial risk management processes. By applying familiar tools such as scenario analysis and stress testing, financial institutions can identify, prioritise and address exposures to climate-related risks, reducing the likelihood of unexpected losses. Proactive assessment of climate vulnerabilities also supports better decisions on provisioning, pricing and client engagement. Climate risk is connected to other areas of risk management in the following ways:

  • Credit risk is likely to increase as physical events damage client assets and adversely affect their cash flows and asset values, while transition policies may leave carbon-intensive assets stranded. For example, the 2025 monsoon season in Pakistan resulted in over 946 deaths, displaced millions, and deepened economic fragility. Over one million acres of farmland were submerged, severely disrupting agricultural output and rural lending portfolios. As extreme monsoons become more frequent, farmers face recurring crop losses, persistent inflation and mounting debt, all of which weaken loan performance across the agricultural sector.
  • Market risk volatility is expected to rise as climate-vulnerable assets are repriced, and commodity markets experience supply and demand shocks. For example, following drought conditions in early 2025, electricity prices in Brazil exhibited high volatility due to the country’s reliance on hydropower generation.
  • Operational risk increases when physical infrastructure, supply chains or workforce productivity are disrupted, with knock-on effects across operations and client portfolios. For example, the Philippines experiences severe typhoons several times a year, often bringing economic activity in affected regions to a standstill.
  • Liability risk can arise when institutions fail to disclose or manage climate risks, exposing them to legal action as global standards become enforceable. For example, a Peruvian farmer brought a high-profile climate lawsuit against German energy giant RWE, and won, setting a precedent for corporate accountability.

• Climate action also presents a growth opportunity
  While climate risks can erode value, proactive climate action has the potential to build resilience and generate long-term financial returns.

  • Financing demand: In many emerging markets and developing economies (EMDEs), green finance is outpacing conventional lending growth, supported by multilateral development banks (MDBs) and development finance institutions (DFIs), investor mandates and rising client demand. Between 2018 and 2022, climate finance to these markets more than doubled in key regions such as sub-Saharan Africa and South Asia, with green lending growing at 10-15% annually. Increasingly, clients are actively seeking capital for adaptation, energy efficiency, renewables and resilient infrastructure.
  • Financing supply: FIs that can demonstrate strong risk management are better placed to access international funding through green lending facilities, green bonds and blended finance mechanisms.
  • Financial product innovation and market share: FIs with a clear understanding of climate risks, particularly physical risks, are better equipped to design new financial products that support adaptation and resilience. Much of today’s climate finance is earmarked for mitigation and transition, creating incentives for FIs to strengthen their management of transition risks. Those slow to act may miss opportunities and lose market share to peers more advanced in green finance.

• Climate risk management is part of strategic decision-making
  Climate change is reshaping the global risk landscape and will continue to influence financial systems for decades to come. Integrating climate risk into strategic planning is therefore both urgent and a key differentiator for FIs seeking to manage credit and portfolio risk effectively. Robust climate risk management practices will support institutions through some of the following ways:

  • Scenario planning and stress testing provide key decision-makers with actionable insights into portfolio vulnerabilities and pathways for diversification.
  • Clear risk appetite statements that reflect climate realities help institutions set boundaries and priorities, supporting transparent and well-grounded decision-making.
  • Embedding climate risk within 3 Lines of Defence promotes accountability and cultural change. Front-line teams can identify and price risks appropriately, risk managers can provide oversight and guidance, and internal audit teams can ensure controls remain effective.
  • Building climate risk into strategic management also strengthens institutional resilience. Proactive portfolio monitoring, client engagement on transition and adaptation, and the inclusion of climate covenants into credit agreements may help institutions respond to uncertainty and change while protecting them legally.

• FIs are becoming trusted stewards of climate finance to attract stakeholders
  Employees, investors and clients increasingly expect evidence of sustainable, climate-aligned business practices.

  • Banks that demonstrate robust climate risk management can attract lower-cost funding, enhance their reputation and deepen relationships with global investors including MDBs, DFIs, and other impact investors.
  • Transparent reporting of climate-related exposures, supported by targeted disclosures, helps meet rising regulatory and market expectations, particularly as IFRS S2-aligned standards are becoming the global norm.

• Climate risk management is a win-win-win for FIs
  For emerging markets FI, managing climate risk is essential. It supports present and future regulatory alignment, protects balance sheet value, opens new commercial opportunities, and strengthens stakeholder confidence, all while helping to future-proof business models.

  Timing is critical. Evidence shows that FIs acting early and decisively are best placed to succeed as climate change becomes a key determinant of financial performance. A 2025 study across ten emerging Asian markets found that climate risks are often mispriced, yet early adopters of robust climate risk management benefit from a lower cost of capital and narrower bond spreads than their peers. When approached strategically and with long-term lens, climate risk management empowers FIs to play a leading role in the green transition.

Principles of climate risk management

Embedding climate risk management within an institution is essential for long-term stability and competitiveness. It strengthens overall resilience, supports compliance with evolving regulations, and helps institutions to identify and capture opportunities arising from the green transition.

Key principles for embedding climate risk management within FIs

Further guidance and case studies for embedding climate risk management within FIs

The UK’s Climate Financial Risk Forum (CFRF) publishes gold-standard guidance for FIs to embed climate risk management practices within their organisations. The World Wildlife Fund (WWF) has catalogued several insightful sustainable finance case studies covering 25 banks across eight sub-Saharan African countries. The Network for Greening the Financial System (NGFS) has reported on developing blended finance solutions for climate mitigation, including details on how FIs in emerging markets can tap into international finance flows.

Enablers of effective climate risk management

FIs that have successfully embedded climate risk management benefit from a high level of coherence between strategy, operations and culture.

• Climate risk tools, methodologies and principles become part of the organisation’s core risk management, credit and governance processes.
• Teams have increased confidence and capability in understanding and managing climate risks.
• Tools and processes drive a culture of continuous improvement and can be further adapted as organisational needs evolve.
• The organisation can show progress towards its strategic goals, while staying agile to market developments and climate shocks.

The following elements can help embed climate risk management within FIs.

• Culture and change management

  • Foster a proactive risk culture where climate risk is part of everyday decision-making, rather than treated as a compliance exercise.
  • Encourage open dialogue and continuous learning on climate risk, empowering staff to raises concerns where they see potential risks.
  • Use change management strategies – such as internal champions, communication campaigns and visible leadership – to embed new ways of working.

• Business line engagement and buy-in

  • Involve all relevant business units early in developing and refining climate risk-related processes to ensure they are practical and relevant.
  • Create structured feedback loops between business lines and risk teams to improve criteria and address operational challenges.

• Strong leadership and visible senior sponsorship

  • Secure active board and executive support for climate risk management, not only for approvals but also for advocacy and accountability.
  • Engage key external stakeholders to reinforce climate risk management as a strategic priority and driver of long-term value and resilience.

• IT systems and infrastructure

  • Integrating climate-related data across business lines into existing analytics dashboards to improve insights and response times.
  • Automate monitoring and escalation to ensure real-time risk awareness and coordinated action.
  • Ensure systems work seamlessly with existing risk and finance platforms to support clear reporting and auditing.

Principles for governance of climate risk within FIs

• Strategic integration at origination and sourcing
  Include climate risk considerations, as well as climate finance opportunities, in business strategies, credit origination and client engagement.
• Climate data collection and analysis
  Collect climate-relevant data for all new transactions, including:

  • Location and asset-level details for physical risk assessment.
  • The client’s Scope 1, 2 and material Scope 3 emissions.
  • Any mitigation, adaptation or transition plans already in place.

• Integrated due diligence and risk rating
  Incorporate both physical and transition risk factors into credit due diligence and client risk profiles. Use these factors to assess:

  • Creditworthiness and collateral strength under different climate scenarios.
  • Climate risk ratings that link to credit grades and lending terms.

• Documentation and credit write-up
  Document climate risk analysis in credit memoranda, including risk ratings, scenario analysis, and any climate-related covenants, to ensure traceability and auditability.
• Informed credit approval and decision-making
  Provide credit committees and other governance bodies with clear and actionable climate risk insights to inform approval decisions.
• Ongoing monitoring, escalation and capability building
  Actively monitor climate risk post-approval through:

  • Regular client engagement and site visits focused on climate metrics and action plans.
  • Tracking gradual and sudden changes in risk, as well as compliance with climate-related covenants.
  • Regularly updating risk management practices as climate science, regulation and market expectations evolve.

• Disclosure and stakeholder transparency
  Clearly define and communicate organisational roles, responsibilities and processes for managing climate risk. Where applicable, publish disclosures in line with international standards such as IFRS S2.

The table below outlines how different organisational layers can contribute to a comprehensive climate risk governance structure. These roles are potential examples and can be integrated into existing frameworks in various ways, depending on the institution’s size, structure, and level of climate risk maturity.

Detailed breakdown of roles and responsibilities

The diagram below shows a best practice governance structure, illustrating how responsibilities flow from the board’s strategic oversight through management accountability to operational delivery across the three lines of defence (3LoD).