Climate change is rapidly gaining prominence as a ‘new’ risk factor to global financial stability, says Generali Investments. The asset manager believes that it will have both a physical and an economic impact on debtors worldwide and their capacity to repay loans.

A study by Generali found that potential risks to global financial stability are not spread evenly across geographical locations and industrial sectors. According to the investment management firm, emerging markets are more vulnerable to the negative financial impacts of climate change compared to their European counterparts. And individual companies stand to lose the most from this predicament as they will have to undergo a green transition without budgetary freedoms, all the while coping with climate change related hazards.

“Climate risks and costs are on a steep upward slope Thus, the true challenge for supervisors as well as financial intermediaries is to prepare for a future, still surrounded by huge uncertainties about the materialisation of the climate scenario,” the asset manager says in its report. 

“The ECB stress tests provide ‘state of the art’ simulations based on three such scenarios” it adds. The test indicates that monetary losses would be minimal in an orderly transition to a low-carbon economy, ensuring global financial stability. In comparison, “doing nothing” would result in huge long-term GDP and other financial losses. It states that climate change will have an impact not just on businesses, but also on sovereign countries as well.

“Regulation is currently overhauling the Basel framework and the EU macroprudential framework. Especially climate specific capital buffers will punish brown sector exposure so that investors will need to carefully scrutinise firms on their ability to decarbonize their activities,” says the asset manager.

“This will need to go hand in hand with more climate modelling expertise and a more in-depth analysis of individual (bank) exposures. Brown sectors and financial institutions with a relatively high brown exposure will likely underperform,” as per Generali.

View the complete study here.