Accelerating climate impacts are causing increasing human and financial harm, resulting in financial system actions by key countries and at the international level. Financial risks include systemic/macroeconomic impacts and reduced access to financial products and services.
Climate-related financial risk has historically been addressed through ‘prudential’ supervision of the banks and insurance firms which, since 2008, have been considered ‘too big to fail’. It has been categorised in terms of ‘physical’ and ‘transition’ risks:
- Physical risks lead to reduced asset values and increased uncertainty in asset markets, as well as higher insurance claims and reduced coverage.
- Transition risks can also include the risk of stranded assets due to policy changes and/or market volatility.
Europe is setting the pace (mostly)
The European Central Bank (ECB) and EU insurance supervisor (EIOPA) have integrated climate-related risks into their prudential toolkits, including conducting economy-wide climate stress tests. They published a policy paper in December addressing insurance protection gaps for natural catastrophes, with EIOPA publishing a related dashboard.
Meanwhile, the EU banking supervisor (EBA) proposed guidelines to address climate risks including the prudential treatment of fossil fuel assets for insurers, the creation of a sectoral systemic capital buffer, and the integration of climate risk into the banking collateral framework.
Unhelpfully, the European Commission’s recent ‘Omnibus’ proposal to limit firms’ obligations to make sustainability disclosures could reduce the availability of climate-related financial risk data in the future.
The UK could regain its early lead
The UK was a leader in responding to climate-related financial risk but has recently been less dynamic than the EU. It could catch up again by giving a clear signal to the Bank of England to prioritise this topic and by continuing to support climate-related disclosures.
Notable UK actions include:
- 2016: Flood Re scheme launched to bridge flood insurance gaps over a 25-year period.
- 2019: Bank of England Supervisory Statement 3/19 set expectations for firms around climate-related financial risks.
- 2021: Biennial Exploratory Scenario stress-tested the UK financial system against climate-related financial risks.
- 2024: Bank of England made changes to its collateral framework for mortgage portfolios with high exposure to flood-prone areas.
- 2025: Financial Conduct Authority reported on challenges faced by financial services firms in relation to climate impacts.
New leadership from Asia-Pacific
There is growing momentum across Asia-Pacific to incorporate climate risk considerations into prudential regimes.
- The Australian Prudential Regulation Authority (APRA) has highlighted its increasing expectations around climate risk – noting that it will ‘elevate climate within the regulatory and supervisory landscape’ with plans to amend specific prudential and risk management standards to include climate risk in 2025. Also, an insurance Climate Vulnerability Assessment is underway with Australia’s largest general insurers.
- The Monetary Authority of Singapore has issued draft guidelines setting expectations for transition planning by financial institutions across climate mitigation and adaptation.
- The Hong Kong Monetary Authority published a circular on good practices for transition planning, committing to release further detailed supervisory expectations.
Increased multilateral action in 2025
Important steps are being taken this year in international forums:
- G20 finance ministries and central banks have created a surveillance tool aimed at consistent and informed risk management across jurisdictions and sectors. It provides metrics for identifying drivers of these risks and transmission channels to the real economy, as well as for quantifying the scale of financial impacts.
- Under the 2025 G20, work is being done on climate adaptation within private sector transition plans.
- Global insurance supervisors (the IAIS) have published a new paper on the supervision of climate-related financial risks, which are increasingly pressing in this sector.
All of this follows several years of work by leading central banks and financial regulators, including the development of climate scenarios used widely around the world for stress-testing against physical impact risks.
What will happen next?
Agreeing on strong actions in multilateral forums can be challenging, however, important progress is being made in 2025, led by individual champion jurisdictions.
As more jurisdictions take action, key areas for focus include:
- Continued economy-wide climate stress testing as the foundation of a comprehensive macro-prudential strategy.
- Considering new capital buffers to build resilience and support transition policies. These can be calibrated using climate scenarios and linked to delivery of transition plans. EIOPA’s proposed capital surcharges for insurers holding fossil fuel assets is an example of what could be done.
- Exposure limits could complement buffers by targeting concentration risks. Sectoral caps on carbon-intensive industries could reduce transition risk exposure in financial portfolios.
- Expectations on firms to disclose climate-related data to help identify, measure and manage climate-related risks should be prioritised, even amid regulatory ‘backlash’ in the UK and the EU.
