Assessment of climate related vulnerabilities

There is a growing focus on potential risks to financial stability from climate change. The
January-September 2024 global mean surface air temperature was 1.5oC above the preindustrial average and 2015-2024 will be the warmest ten years on record. At the same time, global greenhouse gas (GHG) emissions are projected to decrease by 4% in 2030 relative to 2019 levels, as compared to the 28% reduction needed to be aligned with the 2oC scenario and by 42% in order to be aligned with the 1.5oC scenario, which reflects a widening gap between climate goals and action taken globally. Physical risks are resulting in greater economic damage, which may impact institutions’ ability to continue to provide financial services in certain segments and geographies. Transition risks may materialise from abrupt government action to bring policies more into line with the goal of limiting global warming, or changes in investor expectations or preferences. This may result in a sudden re-evaluation of the materiality of
climate-related financial risks by market participants. A large-scale shift in beliefs or awareness
about the economic and financial implications of these risks could cause a significant and abrupt
repricing of climate-exposed assets. Transition and physical risks could have widespread, albeit
heterogenous, impacts across entities, sectors and economies. Given this, financial authorities
in various FSB member jurisdictions are taking steps to integrate climate-related financial risks
in their financial stability assessments.

While climate shocks are transmitted through the financial system via conventional transmission
channels, the channels may differ and warrant particular focus to ensure they are captured well
in financial stability frameworks. Financial risks from climate shocks could materialise via
convential channels used in financial stability assesssments, such as credit, market, and liquidity
risks. However, traditional micro- and macro-prudential approaches tend to rely more on direct
exposures, a shorter time horizon in the materialisation of risks, and historical loss experiences,
which poses challenges on capturing the unique features of climate-related risks. These unique
features include, for example, the forward-looking nature of these risks wherein climate shocks
are expected to grow in terms of their frequency and magnitude, which makes historical data illsuited to assess future impacts. Additonally, there are uncertainties around the timing of climaterelated events and the magnitude of impact, non-linearities from tipping points,3 as well as second-order and spillover effects. There is also the possibility, given these complexities, that climate-related risks may be relatively more opaque and hence mispriced or mismanaged by entities in the financial system. Under these conditions, climate risks could create correlated shocks whose impact can be magnified as they propagate through the financial system, in a similar manner to other unexpected shocks to the economy.
This report describes a framework and analytical toolkit to assess climate-related vulnerabilities
using a forward-looking approach. Building on previous work carried out by the FSB and its
members, the framework traces how physical and transition climate risks could be transmitted
to and amplified by the global financial system. Complementing the framework, the report
includes some metrics that can be used to monitor climate-related vulnerabilities from a forward.

source :

https://www.linkedin.com/posts/kapil-narula_fsb-report-ugcPost-7290409646798856193-yZk_?utm_source=share&utm_medium=member_desktop