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INSIGHT

Climate risk is not ESG risk

19 May 2026

Climate risk is a financial transmission problem.

Climate risk is not an ESG problem, but a financial transmission problem.


Today more and more people talk about climate risk however, unfortunately, it also gets easily dismissed as “ESG is so 2021, it is not relevant to us, this is not my concern” in conversations with organisations and market participants. Now, the problem is that in those organisations, people still struggle to meaningfully consider it in their financial decisions.


This is not because CFOs or risk managers are indifferent but because much of the current conversation still fails to explain how climate risk actually becomes a financial risk in practice.


In other words, the problem is not awareness but it is transmission.


Where current approaches fall short

Most climate risk frameworks still orbit around emissions, reporting, disclosure, and long-horizon scenarios.

These elements matter, but they rarely answer the questions financial decision-makers are accountable for:

  • How does this affect margins?

  • Where does cash-flow volatility emerge?

  • What changes in capital allocation?


When we speak to investors, banks and corporates, they often ask: "How does this make me money?". Studying these aspects and including them in the analysis gives investors the chance to identify interesting opportunities.


Supervisors have been explicit about this gap. The Bank of England’s PRA has been direct that many current climate metrics do not directly quantify financial risk in a way that can be monitored against risk appetite, and that progress across firms remains uneven. The PRA explicitly frames climate risk as a driver that must be embedded into core risk management frameworks, incorporating board and senior management accountability and forward-looking risk identification and mitigation across balance-sheet exposures, not treated as a standalone “ESG” issue.

Supervisors internationally are consistent and aligned in their message: climate risk is financially material only if it is translated into familiar categories (credit, market, liquidity, operational) so it can be priced, provisioned, stress-tested and governed like any other risk. 

The result, in many cases, is a disconnect: climate risk is reported, but rarely used.


The missing middle: financial transmission

The Basel Committee on Banking Supervision (BCBS) has systematically analysed how climate-related risk drivers (both physical and transition) materialise through micro- and macroeconomic transmission channels to affect banks via traditional risk categories such as credit, market, liquidity and operational risk, rather than as a separate ESG bucket. Its analytical work underscores that climate risk drivers do not remain abstract: they influence underlying economic conditions, firm cash flows and asset valuations, and those impacts feed into banks’ risk metrics and capital frameworks.

Physical risk

Physical hazards damage assets and disrupt operations, but the financial story is the second step: impacts on production, logistics, insurance costs, receivables, inventories and working capital.

The ECB has been pushing hard on this “translation” logic with increasingly decision-relevant metrics:

  • In a recent ECB analysis of euro area bank lending, more than 34% of outstanding corporate loan amounts—over €1.3 trillion—were to sectors exposed to high water-scarcity risk. 

  • Using an “extreme but plausible” drought with a 25-year return period, the ECB finds nearly 15% of euro area economic output could be at risk, with particularly large exposure in southern European agriculture. 

  • In parallel, the ECB highlights that under the NGFS short-term scenarios, extreme weather could already put up to ~5% of euro area output at risk over the next five years—which is explicitly framed as a near-term macro-financial concern, not a distant horizon issue. 

This is what transmission looks like: hazard → disruption → borrower cash flows → credit quality → capital and liquidity implications.

Transition risk

Transition risk is often discussed as policy risk but what matters financially is the repricing mechanism: how policy, energy markets, technology adoption and financing conditions change costs and revenues unevenly across firms, and how that flows into valuation and credit metrics.


In the last few weeks, we have heard from the major automotive companies (Stellantis -€22bn, Ford -$19.5bn, GM -$5bn) that had to communicate to the market major charges in their results due to lower EV adoption than expected: this is screaming transition risk and yet we are still debating how much is this worth.

Supervisors are now forcing this into core stress-testing and prudential conversations. For example, the ECB’s Macroprudential Bulletin has explicitly focused on integrating transition and acute physical climate risks into a short-horizon stress-testing framework, precisely to make the results usable for resilience and balance-sheet assessment, not just narrative reporting.


Supervisors are also starting to take action: in November 2025, the European Central Bank has imposed periodic penalty payments totalling €187,650 on ABANCA for failing to complete a required materiality assessment of its climate-related and environmental risks by the supervisory deadline, underscoring the ECB’s enforcement of robust risk-identification expectations for climate exposures. The Bank is intensifying its supervisory focus on climate-related physical risks, with a second penalty that has been issued to Credit Agricole for over €7M more recently.


According to the latest report, the ECB now says that while all significant institutions had integrated climate risk into stress-testing frameworks by the end of 2024, methodologies for physical and nature-related risk are still “in their infancy”, in other words, institutions may still be materially underestimating exposure.


Why this matters now

This gap is no longer theoretical.

  1. Supervisory expectations are tightening. The PRA has moved from “awareness-building” to explicit expectations about governance, risk identification, scenario analysis, and embedding climate risk into standard risk processes—formalised in SS5/25 (published 3 December 2025), supported by its 2025 consultation and policy materials. 

  2. Central banks are publishing operationally anchored metrics. The ECB’s climate indicators now include physical-risk indicators explicitly designed to link hazards to firms’ ability to repay loans and bonds and to equity performance, i.e., directly aligned with financial decision variables.  

  3. The analytical toolkit is shifting toward “near-term” macro-financial stress. The NGFS short-term climate scenarios (released May 2025) were built specifically to support policy-relevant, near-term macro-financial analysis—again reinforcing that the debate has moved from “tragedy of the horizon” to mainstream risk horizons.  

 

What changes if we get this right 

When climate risk is treated as a financial transmission problem: 

  • Stress tests become decision-relevant (because they map into P&L, RWA, liquidity and capital) 

  • Capital allocation incorporates climate drivers explicitly, rather than as a narrative overlay 

  • Climate risk is discussed alongside interest-rate, credit and liquidity risk, where it belongs 


This shift does not require more disclosure alone but it requires better translation between climate dynamics and the financial variables that actually drive decisions. 


Until that translation is in place, climate risk will remain widely discussed, but only selectively acted upon. 

 

Sources 

 

 

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