Climate risk is financial risk. Research suggests that the financial impacts of climate change are already materializing. 

Some studies indicate that climate change could lead to income reductions of up to 19% by 2050, with each degree increase in global temperature potentially leading to a 12% drop in global GDP. 

While public climate finance is critical to delivering a just and resilient future for citizens of emerging economies, financial institutions and the private sector have a key role to play.

It is urgent that financial institutions integrate climate risk management into their operations to deal with climate change’s ever-increasing physical impacts and turn the low-carbon transition into an opportunity. 

In fact, in 2017, the G20 (the world's largest economies) established a series of recommendations regarding this fundamental link between climate and financial risks.

This led to the IFRS Foundation's publication of disclosure standards through the International Sustainability Standards Board (ISSB) in 2023.

Current State

In 2023, IDB Invest surveyed the Chief Executive Officers of 32 banks and financial institutions in Latin America and the Caribbean to gauge their understanding and approach to climate change risk. 

The findings revealed a growing awareness of the importance of recognizing and addressing climate risks and opportunities (see graphic). 

Climate physical risk is the CEO's most significant concern in the short term. In contrast, transition risk is less pressing. Notably, 16% believe it will not affect their business at all.

The data depicts that many need more preparation to identify, assess, and manage these risks effectively. 

While Brazil and Chile, for example, embed climate risk disclosure into national regulatory frameworks, the lack of comprehensive regulation, uniform reporting standards, and enforcement mechanisms, remains a significant obstacle. 

Respondents also pointed out a lack of adequate tools, data, and understanding of standards, insufficient comprehension or demand from their clients, inadequate understanding of climate risk, and lack of commercial prioritization.

The Strategies

The IDB Group is committed to helping banks understand, navigate, and manage climate risk through capacity-building initiatives.

One coalition that supports financial institutions in transition and decarbonization efforts is the Glasgow Financial Alliance for Net Zero (GFANZ).

WATCH THE WEBINAR "Más que un compromiso: planear y financiar la transición" (More Than a Commitment: Planning and Financing the Transition) 

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The Alliance collaborates with banks, asset managers, and insurers, to create a cohesive framework that supports the financial sector in achieving net-zero emissions.

To achieve this, the Alliance recommends these institutions to focus on three strategies:

• Governance and Culture: Financial institutions must integrate climate considerations into their governance structures. This includes aligning executive remuneration with climate goals and fostering a culture prioritizing sustainability.
• Implementation and Engagement: Effective implementation of climate strategies requires collaboration with clients and stakeholders. Financial institutions should engage with their clients to understand their needs and support their transition to net-zero.
• Transition Planning: Developing a robust transition plan is essential. This plan should outline the steps the institution will take to achieve its net-zero commitments, including setting interim targets and identifying necessary investments.

Significant Progress

Implementing transition plans can be challenging, especially for institutions starting from scratch. 

A first step is conducting a gap analysis to understand current capabilities and needs. CEOs of financial institutions in the Caribbean surveyed by IDB Invest identified this analysis as critical. 

Banks in the Andean Region, Central America, and Mexico highlighted the need to conduct climate risk assessments as pilots in segments of their portfolio.  

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Financial institutions should also support their efforts by leveraging existing frameworks and best practices, such as the ISSB standards and the Net-Zero Banking Alliance's guidelines.

While progress has been made in the journey towards effective climate risk management, financial institutions must continue deepening their understanding and improving their management. 

Sector initiatives, including those by banking associations, should play a pivotal role in this journey. IDB Invest just launched the enlaces regional network, which includes ten sector initiatives, to promote sustainable finance in the region. 

New Opportunities

Financial institutions are crucial in mitigating climate risks and unlocking new economic opportunities by adopting comprehensive transition plans and collaborating with stakeholders. 

Those plans impact whether the low-carbon transition materializes as a risk or an opportunity. 

The survey findings underscore the need for more robust regulatory frameworks, enhanced tools and data, better client engagement, and improved internal awareness to overcome the barriers to effective climate risk management.

As the world moves towards a sustainable future, the financial sector’s credible commitment to net-zero emissions will be crucial in ushering in this era.

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