Question: What are the 'climate change risks ' ?
Ans: There are essentially two types of risks emanating from climate change that we need to address: physical, and transition risks.
a) Physical risks :-
Physical risks stem from both gradual and sudden climate impacts, such as natural disasters, affecting real assets and financial instruments.
These risks cause direct damage to assets, leading to loan losses and collateral damage, as well as indirect costs, including business disruptions, capital replacement, and supply chain issues.
These risks can affect trade, fiscal policy, monetary policy, and financial stability, requiring ongoing assessment. Estimating loan losses from physical risks is difficult due to lack of historical data on such losses, as financial institutions have not tracked them.
Even the available data is of limited use due to the changing frequency, intensity, and location of physical events making projections based on past data a bit risky. Such data on loan losses is important for financial institutions as they impact credit risk, including the probability of default and loss given default.
b)Transition risks :-
Transition risks arise from efforts to mitigate climate change. It arises from the need for transition by the firms and economies as they strive to achieve their net zero targets, which can be disruptive.
It could be a result of adaptation to low carbon technologies, as well as change in consumer behaviour, investor preferences about investments to specific sectors.
It can also be a fall out of climate related regulations such as carbon pricing and taxes, transparency requirements, products, and service regulations.
Thus, the transition risk emerges because of a disconnect arising from the expectations of various economic factors and could lead to rapid economic adjustment costs in a broad range of sectors. It creates uncertainty for firms and investors, which may further lead to financial risks, with its resultant impact on financial stability.
