Addressing climate-related risks in banking: a framework for sustainable risk management and regulatory alignment

Neha Chhabra Roy

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This study explores different strategies used by financial institutions to mitigate climate-related financial risks, including stress testing, scenario analysis, and green finance.
We emphasize the importance of standardized frameworks for assessing physical and transition risks, and identifies significant gaps in existing risk quantification methods.
Our research reveals regional differences in climate risk mitigation, with developed economies concentrating on complying with regulations and emerging markets prioritizing adaptation.
The findings advocate a comprehensive, cross-jurisdictional framework that aligns financial regulations with climate risk management practices.

Abstract

Banks must develop an adaptive and structured response framework for managing climate-related risks. This study proposes a dual-layer approach to climate risk management, integrating root cause-based analysis with severity assessment to prioritize and address climate-related risks. Using sectoral impact analysis, risk prioritization and risk driver identification, the study employs advanced methodologies, including a random forest machine learning model and correlation analysis, to develop a data-driven climate-related risk-response system. Dual-layer mitigation ensures that both the underlying causes and the impacts of risk are systematically considered, improving the accuracy and effectiveness of climate risk response. By improving financial institutions’ risk assessment, loan planning and decision-making capabilities, the proposed framework aims to strengthen climate resilience. This study provides actionable insights and practical tools for banks, regulators and industry stakeholders, promoting sustainable practices and enhancing climate resilience.

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