Climate Change and the Financial System

Abstract

The financial system could help achieve the global climate targets by aligning investments to sustainability. However, investors are largely exposed to carbon-intensive assets that could become stranded, thus delaying the low-carbon transition and bringing new sources of risk for financial stability, i.e., climate-related financial risks. Here, we discuss climate-related financial risks, the challenges they pose to traditional economic and financial risk assessment, and the implications for the implementation and feasibility of climate policies. We then present science-based approaches that introduce forward-looking climate risks and their deep uncertainty in financial risk management (e.g., via the climate value at risk, climate spread, climate stress-test). Finally, we present results of applications aimed at pricing climate risks in investors’ portfolios and calculating the largest losses that could lead to systemic risk, in collaboration with leading financial institutions.