Business on the Edge 2024

Financial services underpin global economic stability and growth by spreading financial risk and allocating resources efficiently. Financial institutions bear financial risk through the loan, investment and underwriting portfolios they hold. Through their portfolio emissions – which are on average over 700 times larger than their direct operational emissions – financial institutions can have a material impact on climate change.129 This underscores the need for more comprehensive management of financed emissions. The financial services system is currently confronted with macroeconomic pressures of high interest rates, inflation, economic slowdown and a global debt crisis. The interconnectedness of financial institutions implies that risks, including climate risks, can be transmitted throughout the entire system, and feedback loops with other sectors can cause risk to spread rapidly and uncontrollably if not identified, managed and mitigated.130 Physical and transition climate risks affect business models Physical and transition climate risks are likely to affect the strategies, business models and financial performance of financial services companies, impacting lending, investment, insurance and reinsurance products. As extreme weather events such as tropical cyclones, coupled with rising sea levels, render coastal properties uninsurable, mortgages and loans are likely to be written off as default rates rise. As physical and transition risks intensify, contagion could spread beyond financial markets and cause broader economic disconnections and dislocations, transmitted for example via global supply chains.131 A cycle of more expensive financing and higher insurance premiums would reduce the ability of consumers and businesses to spend and invest. Stranded assets132 would move beyond the fossil fuel industry to other sectors as climate risks intensify.133 While diversification provides a degree of risk management, particularly in the short- to medium-term, more work is needed to understand how different climate scenarios, and the physical and transition risks that arise, may translate into financial impacts for companies and financial firms. Climate hazards pose systemic risk to entire finance sector The systemic risk posed by climate hazards threatens the entire financial services sector. The materialization of physical risks could lead to system-wide shocks and high volatility of financial markets, causing sharp asset price corrections that simultaneously affect multiple financial institutions holding these assets.134 This can lead to cascading failures across the entire system.135 International financial institutions such as the World Bank and International Monetary Fund play a crucial role in maintaining financial security by coordinating capital flows in regions facing climate risks and providing risk-sharing arrangements.136 These institutions should continue to lead on adaptation and resilience finance, using tools including guarantee products, co-financing and catastrophe bonds. Business on the Edge: Building Industry Resilience to Climate Hazards 41