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Climate change, environmental sustainability, and
financial risks: are we close to an understanding?
Marco Migliorelli
1,2,
*
Climate change and other threats to environmental
sustainability will have an increasingly material impact on
nancial actors. However, transmission channels and possible
spillover effects remain understudied. This review paper
summarizes recent works published on these intersections and
portraits venues for further research. In this respect, late
advances on the control of the impact of climate change-related
risks on nancial risks have been relevant. New climate
scenario analyses, stress testing techniques, and disclosure
requirements have been recently introduced. Existing risk
management frameworks are being updated to integrate
climate change-related risks. Yet, as the development of new
practices continues, the need for assessing their effectiveness
and limitations, from a risk management as well as a nancial
stability perspective, remains. In this vein, sufcient attention
needs also to be paid to emerging market failures linked to
climate change. These include noninsurability of risks and credit
rationing or mispricing, potentially hampering adaptation and
mitigation investments in some areas. Last, while focus has
been put thus far mainly on climate change, time has come to
accelerate the debate on the nancial implications of other
threats to the environment. This is notably the case of loss of
biodiversity, by also taking stock of the work of the Conference
of the Parties (COP).
Addresses
1
European Commission, Rue de la Loi, Brussels, Belgium
2
IAE University Paris 1 Panthéon-Sorbonne (Sorbonne Business
School), 12 Rue Jean Antoine de Baïf, 75013 Paris, France
Corresponding author: Migliorelli, Marco
(marco.migliorelli@ec.europa.eu)
*
The contents included in this chapter do not necessarily reect the
ofcial opinion of the European Commission. Responsibility for the in-
formation and views expressed lies entirely with the author.
Current Opinion in Environmental Sustainability 2023, 65:101388
This review comes from a themed issue on Climate Finance, Risk
and Accounting
Edited by Rosella Carè, Othmar Lehner and Olaf Weber
For complete overview of the section, please refer to the article
collection, “Climate Finance, Risks and Accounting”
Available online 2 December 2023
Received: 29 August 2023; Revised: 23 October 2023;
Accepted: 9 November 2023
https://doi.org/10.1016/j.cosust.2023.101388
1877–3435/© 2023 The Author(s). Published by Elsevier B.V. This is
an open access article under the CC BY-NC-ND license (http://
creativecommons.org/licenses/by-nc-nd/4.0/).
Introduction
The nexus between sustainability and nancial risks is
an emerging eld of research laying in the intersection
between natural sciences and social sciences. It has to
be encompassed in the general discourse on the re-
lationship linking nowadays sustainability and nance,
and for which an increasing volume of research is being
made available focussing on the investigation of the
role of nance in shaping a more sustainable society
(e.g. [40,51,67]). Frameworks such as sustainable -
nance, green nance, and impact investing, among
others, are at the heart of this effort (e.g. [44]). This
body of literature has been incentivized by an un-
precedented political commitment toward sustain-
ability, mainly built around the Paris Agreement and
the Sustainable Development Goals (SDGs), and the
consequent engagement of policymakers and regulators
to deliver on the transition objectives.
This review paper aims to provide a concise overview of
the recent works published on the relation between
environmental sustainability and nancial risks, with a
focus on the implications for banks and insurance com-
panies. In this respect, it acknowledges the prominent
role given thus far by researchers and public institutions
to the investigation of the impact of climate change on
nancial risks, vis-à-vis other possible threats to en-
vironmental sustainability. These latter include loss of
biodiversity, depletion of nonrenewable natural re-
sources, pollution (in its different forms), deforestation,
soil degradation, and overuse or misuse of waters, to
name some. The recognition of this imbalance in lit-
erature represents a rst useful outcome of this paper,
and calls for new venues of research.
Climate change as an emerging source of
financial risks
Evidence of global warming caused by human activities
and its impact on climate change is now consolidated
[35,36]. However, the understanding of how the effects
of climate change relate to the risks in the remit of -
nancial intermediaries, in particular banks and insurance
companies, is still at a relatively early stage of develop-
ment. Seminal, awareness-rising contributions have ei-
ther described the mismatch between the long-term
occurrence of climate change-related risks and the ty-
pical short-term risk-taking strategies of nancial
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www.sciencedirect.com Current Opinion in Environmental Sustainability 2023, 65:101388
intermediaries as the ‘tragedy of the horizon’ [20], or as-
sessed the likely nonlinearity and fat-tailed distributions
featuring climate change-related risks, coupled with the
lack of data on their economic impacts and of adapted
risk management frameworks, as the ideal conditions for
a ‘green swan’ [13]. In this respect, physical risk, transi-
tion risk, and liability risks have been identied as the
main drivers of the diffusion of climate change-related
risks to nancial intermediaries, primarily through the
client they serve, which may be directly concerned (e.g.
[4,9]). This is mainly the case of businesses but it also
refers to households and public administrations, not-
withstanding the at least theoretical possibility of direct
impacts of climate change-related events on nancial
intermediaries. Some relevant attempts have been re-
cently produced as concerns the identication of the
features and the functioning of the specic transmission
channels and of possible spillover effects [9,45]. Yet,
very limited empirical evidence still features the eld.
The increasing consideration of the materiality of cli-
mate change-related risks at rm as well as nancial in-
termediary level has eventually raised the question of
the possible implications in terms of nancial stability
(e.g. [6,10]). Similarly, it has paved the way to interna-
tional initiatives in support of climate-related nancial
disclosure [27,60,61] and the development of sustain-
ability accounting standards [37].
The climate change argument for nancial risks hence
mainly converges toward the need of assessing the im-
plications of climate change-related risks on the risks under
management by nancial intermediaries, in particular
credit risk, market risk, liquidity risk, liability risk, re-
putational risk, and even operational risk [9,43]. Figure 1
gives a general overview of the dynamics under discussion.
An increasingly warning evidence on the
impact of climate change on financial risks
Recent axes of development of literature
Academic researchers have lately contributed to this as-
sessment either indirectly by investigating the existence
and the magnitude of transition risk and physical risk for
specic economic sectors or geographical areas (e.g.
[25,32,56]), or more directly by trying to observe the sen-
sitiveness of various nancial risks or returns to climate
change-associated variables (in particular carbon emissions)
for large samples of banks or stocks (e.g. [12,63,64]). On
the other hand, regulators and nancial intermediaries,
having in mind respectively the need to preserve nancial
stability and integrate climate change-related risks in ex-
isting risk management frameworks, have prompted the
development of forward-looking computational modeling
(notably scenario analysis) and stress testing, taking as a
reference the asset and liability composition at a single -
nancial intermediary level (e.g. [3,49,8]).
Climate change-related risks and financial
intermediaries
Recent literature focussing on transition and physical
risks provides warning evidence. Results have been
produced supporting the thesis that climate change
should be already today considered a signicant source
of risk on the rm value [18,63]. To this extent, investors
are starting demanding compensation to businesses re-
sponsible for carbon emissions [11••,19], and to those
more exposed to temperature rise, as perceived sig-
nicantly riskier [64]. The introduction of carbon taxes
and other policies aiming at supporting the achievement
of the objectives of the Paris Agreement is recognized as
the main source of transition risk for rms, by triggering
stranded assets [17,23,42]. However, accurate quanti-
cation of both transition and physical risk still remains a
substantial challenge for the industry, as well as puzzles
policymakers [53]. In addition, these risks can also be
exacerbated for rms by a rising number of successful
climate litigations [55,57].
These trends are generally conrmed by literature
leading the observation from the nancial intermediation
perspective, even though conclusions remain in this case
more nuanced. Studies show that banks’ exposure to
climate change-related risks, especially if acquired via the
lending channel, mostly lowers banks’ stability and in-
creases tail risks [10,25,66]. However, the impact on
banks may differ based on the type of climate change-
related risks, the banks’ size and business model, and
even their location [15,39]. In this line, recent evidence
suggests that incremental credit risk for banks stemming
from the introduction of an even heavy carbon tax may
result to be mild [1••]. This also highlights the relevance
of the risk management layer in shielding banks from the
transmission of climate change-related shocks. On the
other side, the transition to a low-carbon economy may
generate a signicant shift in the banks’ protability de-
pendence on specic sectors, with emerging clean sectors
taking an unprecedented prominent role [65]. This would
reinforce the need for banks to consider climate change as
a topic of strategic relevance and ensure its integration in
the governance processes, including at board level [16•].
As concerns more specically insurers, although less ex-
plored, late literature similarly advocates that the ex-
posure of insurance companies to natural disasters and
other climate change-related risks may decrease prot-
ability and risk-sharing capacity [66].
To investigate the level of preparedness of market actors
to manage climate change-related risks, nancial reg-
ulators have recently run a series of climate stress tests
[5,28]. The main aim was to assess the robustness of the
climate scenarios recently developed by nancial inter-
mediaries, as well as the level of integration in the ex-
isting risk management frameworks (e.g. [3,5]). In this
respect, climate scenarios considered both transition and
2Climate Finance, Risk and Accounting
www.sciencedirect.com Current Opinion in Environmental Sustainability 2023, 65:101388
physical risk: in the former case by typically taking into
account ‘orderly’ and ‘disorderly’ transition pathways (e.g.
[7,28]), in the latter by anticipating different tempera-
ture rise and climate change patterns. As of today, cli-
mate scenario analysis can be considered still in its early
days, with notable data gaps making projections of cli-
mate change-related losses (in particular as concerns
credit and market portfolios) remaining uncertain [5].
Yet, some relevant developments in methodologies can
also be observed, including the adaptation of Value at
Risk techniques to integrate climate change-related risks
[24]. Looking forward, the principle that the design of
the measurement methodologies should be conducted
according to nature, size, and signicance of the con-
cerned nancial institutions would need to guide both
industry and regulatory efforts.
Climate change-related risks and financial stability
The issue of the implications of climate change in terms
of nancial stability is also increasingly discussed in lit-
erature. Recent evidence has conrmed that physical
risks and transition risks can exacerbate nancial sys-
temic risks, even though limited to the occurrence of the
most adverse climate scenarios [22,41•,54•]. At the same
time, except for the (relevant) efforts for the integration
of climate change-related risks into existing risk
management frameworks and for better disclosure, the
debate on how to mitigate systemic risk linked to cli-
mate change remains open. In this respect, the micro-
prudential framework and related banking regulation
have thus far not evolved signicantly. Capital buffers
and measures limiting exposure concentration have been
proposed only recently [34]. In this respect, in framing
the most effective regulatory approach, key elements
such as the size of the nancial institution and the in-
tensity of the climate change-related risks at a single-
institution level need to be taken into account. This
debate overlaps with the one on the potential role of
both prudential regulation and monetary policy in
speeding up the transition, with key trade-offs still to be
disentangled (e.g. [6,58,31]). This can be the case of a
supporting (punishing) factor consisting in lowering
(increasing) capital requirements for banks detaining
green (polluting) assets, that could contribute to in-
centivize new investments in clean industries but also
elicit uncertainties in terms of both its macroeconomic
and nancial stability feedback [26]. Similarly, the op-
portunity of taking into account any environmental
consideration or the economic impact of climate change
in the formulation of the monetary policy remains
questioned, as it could interfere with the main objective
of central banks of maintaining price stability [14,48].
Figure 1
Current Opinion in Environmental Sustainability
A (very) simplied risk chain linking climate change-related risks and nancial risks. Note: A — In this gure, nancial intermediaries include banks and
insurance companies. B — Transition risk impacts mainly businesses. It may stem from policy and technology shifts linked to the combat to climate
change, which can inter alia trigger stranded assets. Transition risk could also follow market-driven more stringent nancing conditions for polluting
sectors and, more generally, a permanent change in market preferences toward more sustainable products or companies. C — Credit risk concerns
banks only.
Source: Author’s elaboration.
Are We Close to an Understanding? Migliorelli 3
www.sciencedirect.com Current Opinion in Environmental Sustainability 2023, 65:101388
The need of considering other environmental
sustainability threats and further research
Biodiversity loss as an emerging cause of financial risks
When it comes to their impact on nancial risks, the
different environmental sustainability threats have been
thus far addressed by policymakers and researchers in a
substantially separated manner [38•], with signicant
advances referable to date only to climate change. In
particular, thanks to the encouraging output of COP15,
hazards to biodiversity and actions to reduce biodiversity
loss have recently received revamped attention [21]. In
this respect, recent literature has already hinted that
biodiversity loss can be at a larger extent considered
another cause of stranded assets [17], be potentially
material for banks [59,62], and that its materiality should
be better assessed focusing on the local level due to the
nature of biodiversity impacts and their dependencies
[46]. To widen knowledge on the entire spectrum of
environmental sustainability-related risks, while the
policy and research patterns developed to address the
nancial implications of climate change can be broadly
replicated, a standardized approach should not be used.
In this respect, neglecting possible interactions between
the different environmental sustainability-related risks
(e.g. between climate change and biodiversity loss) as
well as their idiosyncratic characteristics (e.g. the time
horizon of their expected materiality) may lead to in-
accurate conclusions. This could undermine both pro-
gress on climate policies and the emerging work on
biodiversity loss-related nancial risks [38•].
Further areas of research and new market failures
Yet, to reach a fair understanding on the relationship
featuring environmental sustainability and nancial
risks, at least two additional areas of research would need
to be further developed in the next years. The rst refers
to the effectiveness of the nancial and management
practices adopted by nancial intermediaries and busi-
nesses to mitigate the impact of climate change and
other environmental sustainability-related risks on their
nancial risks. This assessment should include the ob-
servation of the results of the progressive integration of
environmental sustainability-related risks in existing risk
management frameworks and in the overall governance
structure [8]. These aspects could integrate the wider
literature already addressing the link between ESG
(environmental, social, and governance) performances
and nancial performances of rms (e.g. [2,30,47,29]).
Outputs of such analyses could also inform the policy
and industry debate on the structuring or rening of the
sustainable nance frameworks currently present in the
market. In this vein, an analysis on whether the issuance
of securities such as green or sustainability-linked bonds
contributes to reduce the inherent risk for rms linked to
climate change and other environmental sustainability
threats is also pertinent.
Finally, a relevant area of further research concerns the
possibility of the emergence of new market failures di-
rectly caused by climate change or other environmental
sustainability threats. Non-negligible market failures
may stem from the increasing awareness by nancial
intermediaries of the materiality of these threats and the
likely increase over time of the frequency and magni-
tude of tail events [35]. An argument can be made ac-
cording to the idea that conditions for noninsurability of
risks (e.g. in areas increasingly subject to extreme
weather events) and credit limitations or mispricing (e.g.
for companies in polluting industries) can emerge in the
near future in specic geographies or economic sectors.
This may follow a progressive increase in the cost of
accessing nancial services for businesses and house-
holds subject to physical or transition risks, which lit-
erature has in turn started to point out [33,50••,52••].
The social implications of this possible outcome, in-
cluding in terms of nancing mitigation and adaptation
initiatives, should be further assessed and effective
policy and industry responses proposed.
Data Availability
No data were used for the research described in the ar-
ticle.
Declaration of Competing Interest
The authors declare that they have no known competing
nancial interests or personal relationships that could
have appeared to inuence the work reported in this
paper.
References and recommended reading
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•• of special interest
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6Climate Finance, Risk and Accounting
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