Climate-related financial risks

Climate change: A world of risks

People around the world are feeling the effects of climate change through increased frequency and impacts of floods, changes in temperature, and shifts in consumer demand toward products with low greenhouse gas (GHG) emissions. Climate change impacts could hurt your business by affecting your operations and supply chain—and could soon start to show up as real dollar consequences for your business.

The impacts of climate change on a business can be categorized as physical risks or transition risks, as shown in the top row of the above graphic. Physical risks are the result of the physical effects of climate change, such as changes in temperature, precipitation patterns, extreme weather events, and water availability. Transition risks arise when society takes action to mitigate or adapt to climate change and shift to a low-carbon economy. Two examples are the introduction of a new climate policy or a shift in consumer demand toward more climate-friendly products—both of which businesses will need to adapt to.

Deloitte and the Environmental Defense Fund (EDF) recently published two resources highlighting the climate-related financial risks that banks financing the agriculture sector face and strategies those banks can take to manage those risks by proactively helping address the underlying climate risks on farms and ranches. Deloitte and the EDF surveyed 167 agricultural finance institutions and found that 87% expect climate change to present material risks to their businesses in the future. Deloitte and the EDF’s findings from the agriculture finance sector provide helpful insights for businesses and banks across the economy.

In financing agriculture or in other forms of business, physical and transition risks can affect the traditional risk categories that business leaders are familiar with, including credit, market, liquidity, insurance, operational, and reputational risks.¹ These risks are shown in the bottom row of the graphic. Each of these risks is interconnected and can have reinforcing effects that further increase the impact of climate risks on finance institutions, especially institutions that work with organizations that could be heavily impacted by physical or transition risks, like farms and ranches.

Climate risks can manifest as financial risks in different ways. Consider these two hypothetical risk examples from agriculture finance:

• Example 1: A farm you finance does not adjust its crop rotation to adapt to lower annual precipitation and experiences low crop yields more frequently as a result. This tightens the farm’s cash flows, leading to default. Your business has a reduction in cash inflow—and lower revenue and profits—because the borrower fails to repay part of the interest and principal of the loan. The decrease in cash inflows grows if more farmers in your region have not adapted to the changing precipitation patterns. Conversely, those finance institutions that seize the opportunity to introduce financial and advisory products to help farmers transition to climate-resilient crop rotations could see both a growth in market share and a relatively lower impact from climate risks.
• Example 2: Your business does not assess potential impacts from a shift in demand away from food products that consumers believe contribute to significant GHG emissions. Your borrower has an unforeseen decrease in sales because the crops or livestock are not grown using low GHG technologies, which buyers are increasingly demanding. The decrease in sales decreases your borrower’s revenue and profits and restricts cash flows. The borrower is unable to repay the loan, leaving your business with lower cash inflows, revenue, and profits. Again, a converse opportunity for proactively supporting borrowers to adapt to changing markets exists, and other lenders are filling that demand.

These examples from the agriculture finance sector show that physical and transition risks from climate change can cause business risk. To protect your business and position it for success, start proactively addressing climate risks—and look for the business opportunities inherent in addressing them.

To learn more about how climate risks can directly affect your business and what you can do, refer to Deloitte and the EDF’s survey of agricultural finance institutions and guide to addressing climate risks.

Endnote

¹ Basel Committee on Banking Supervision, Climate-related risk drivers and their transmission channels, Bank for International Settlements, April 2021.

Get in touch

Steve Watkins Strategy leader for Climate, Climate Sustainability and ESG stewatkins@deloitte.com	Karen Moik Manager for Climate, Climate Sustainability and ESG kmoik@deloitte.com