When climate risk becomes credit risk

For international banks, export credit agencies and globally active exporters, climate change can affect sovereign repayment capacity, project schedules, supply chains and insurance costs. Yet sophisticated climate frameworks can still obscure a basic question: what risk is being measured, and for what purpose? Opening the Berne Union discussion, moderator Karin Wessman, Head of Sustainability and Country Analysis at EKN, asked how different institutions should understand, manage and absorb climate-related risk - and what their choices mean for access to finance.

Lisa Sachs, Director of the Columbia Center on Sustainable Investment, argued that the starting point is to separate three related but distinct layers. Planetary risk covers the physical effects of climate change, including heat, floods, wildfires and coastal erosion. Some of these effects become economic risks when they damage livelihoods, infrastructure, output or public finances. A smaller subset becomes financial risk when it impairs credit quality, asset values or balance sheets.

The transmission between these layers is not automatic. Resilient infrastructure, insurance, reconstruction finance and public guarantees can dampen, delay or redistribute the transmission of a physical shock into an economic crisis or financial instability. A bank assessing its residual exposure is therefore measuring something different from a climate scientist examining physical hazards.

The only thing that reduces the underlying planetary risk is decarbonising the global economy; all of the other responses, important as they are, manage the growing consequences of the underlying risk.

Lisa Sachs, Director of the Columbia Center on Sustainable Investment

That distinction matters because different responses do different things, and they sit with institutions that have different mandates. Mitigation reduces the underlying danger by cutting emissions. Resilience reduces the damage when hazards strike. Insurance and public risk-sharing mechanisms spread losses once they occur. Lenders, insurers and investors manage their own exposure through underwriting, pricing and allocation, which protects their balance sheets but does not reduce the hazard. Supervisors and central banks assess risk in order to safeguard institutional soundness and financial stability. Expecting every institution to assess a single entity called climate risk and then act in a way that collectively solves it is, Sachs said, "fundamentally flawed and wrong". She added: "The only thing that reduces the underlying planetary risk is decarbonising the global economy; all of the other responses, important as they are, manage the growing consequences of the underlying risk."

Translating physical hazards into financial numbers

Ioana Dima-West, Head of Science and Natural Perils at AXA XL, showed why translating physical hazards into financial numbers is rarely straightforward. Rising insured losses cannot simply be attributed to climate change. Inflation, the growing number and value of buildings, development in exposed locations and changes in vulnerability may all have a greater effect on losses today.

Insurers therefore model risk through several components: hazard, exposure, vulnerability and the financial terms of the policy. Ioana distinguished climate models, which simulate the Earth system and project future conditions, from catastrophe models, which generally use historical experience to estimate present-day losses. Practitioners must connect the two, adjusting catastrophe models as the science and the physical baseline change.

What happens in the past has to be assessed and included in your view of risk.

Ioana Dima-West, Head of Science and Natural Perils at AXA XL

One AXA XL review, for example, found that a US hurricane catastrophe model relied on 2008 sea-level data. Updating the storm-surge component within increased its estimate of average annual loss by about 3.3 per cent. The number was portfolio-specific, but the lesson was broader. "What happens in the past has to be assessed and included in your view of risk," Ioana said. Institutions must ensure that pricing reflects changes that have already occurred, then stress-test exposures against credible future scenarios.

The work remains iterative because scientific studies may use different warming assumptions from an insurer's own scenarios. Robust estimates, Ioana stressed, must look beyond the hazard itself and keep exposure and vulnerability in view.

From an unpriceable threat to a bankable structure

John Lentaigne, Global Head of Structured Credit and Political Risks at Specialist Risk Group, brought the discussion to African sovereigns and projects. Climate risk seldom arrives on an underwriter's desk under that label. It appears as fiscal stress and arrears after drought, agricultural and small-business defaults on bank balance sheets, insecurity around major projects, damage to coastal assets or long-term uncertainty over offtake.

Climate multiplies risks that the market already prices. It's not a new peril sitting alongside it.

John Lentaigne, Global Head of Structured Credit and Political Risks at Specialist Risk Group

His formulation was blunt: "Climate multiplies risks that the market already prices. It's not a new peril sitting alongside it." A shock cuts government receipts just as emergency spending rises. Foreign exchange and liquidity pressures then produce arrears; subsequent borrowing becomes shorter and more expensive; and the sovereign enters the next shock with less room to respond. Where insurance coverage and fiscal buffers are thin, the public treasury becomes the insurer of last resort.

For underwriters, the obstacle is often less the presence of risk than uncertainty about its scale. "Underwriters can price risk, but they can't price ambiguity," Lentaigne said. Better rainfall and crop-yield data, early-warning systems and explicit provisions for what happens after a disaster can therefore change a financing decision.

Several structures already point the way. Parametric insurance* can pay quickly when a predefined threshold is crossed. First-loss layers supplied by development institutions can bring private insurers into markets or tenors they would otherwise avoid. Climate-resilient debt clauses can pause payments after a hurricane or failed harvest, allowing a sovereign to defer rather than default.

Climate exposure creates new demand

For Export Credit Agencies (ECAs), the practical agenda is to embed climate in country models, stress-test sovereigns through a bad year, share risks and extend tenors. Selective, well-structured support matters because wholesale retreat can raise capital costs, weaken states and accelerate the instability that lenders fear. Africa is not one market, Lentaigne emphasised, and climate exposure can itself create demand for irrigation, energy storage, stronger grids, cold chains and transition minerals – all sectors in which exporters and their international banking partners have relevant technology and expertise.

For banks, ECAs and exporters, the practical task is not simply to avoid exposed countries and projects. It is to locate the risk precisely, allocate it to the institution best equipped to carry it, and use guarantees, insurance and resilient financing terms to keep commercially and environmentally essential investment moving.

Karin Wessman, Head of Sustainability and Country Analysis, EKN

Sachs distinguished making what is already being financed more resilient from the question of “what are we trying to build in the first place that reduces the underlying risk, and how do we make that financeable?” That second question is where ECAs matter most. Sound projects in emerging and developing economies sometimes fail to reach financial close because of specific risks, such as first-of-a-kind technology, political, currency or offtake risk. An ECA’s public mandate is to reallocate exactly those risks. Its most direct climate contribution is to make decarbonized systems financeable, not to cut its own portfolio’s financed emissions.

The speakers approached climate risk from different directions, but their conclusions converged. Better measurement protects balance sheets; intelligent structuring expands what can be financed, said Wessman in her conclusion:

“For banks, ECAs and exporters, the practical task is not simply to avoid exposed countries and projects. It is to locate the risk precisely, allocate it to the institution best equipped to carry it, and use guarantees, insurance and resilient financing terms to keep commercially and environmentally essential investment moving.”