German watchdog says companies must assess physical risks from climate change

Climate change could create or exacerbate existing risks to the German financial system and financial institutions need to better understand the physical risks from natural disasters caused by climate change, Germany’s financial regulator BaFin said.

While transition risks are also relevant, regulation and supervision have not paid enough attention to physical risks. As a result, BaFin will pay particular attention to climate change risk in 2025, president Mark Branson said.

“A forward-looking approach will not only protect the solvency of insurers and banks, but also be able to drive prevention measures forward. If risks are properly priced, it is more likely that they will be mitigated.”

Speaking at a press conference on the risks that BaFin plans to focus on in the coming year, Banson said the regulator was looking closely at banks and insurers that are at risk due to extreme weather, supply chain dependency or concentrated credit and market risk.

“We have found that the companies have generally made progress in managing their sustainability risks, but there is still room for improvement,” he said.

The need to manage climate change risk has been accentuated by the recent flooding in Valencia and wildfires in LA. The European Central Bank (ECB) has asked banks to factor in climate risk into how they do business, while Europe’s insurance regulator has recommended higher capital requirements for insurers’ fossil fuel assets.

Many companies lack data, such as the locations of customers or public flood protection measures. Banks, in particular, are still in the early stages of building their data, Branson said.

Still, he noted that historical data has limited value because the risk from climate change changes rapidly.

“It also seems plausible to me that climate change could become a driver of another highly charged geopolitical issue: migration,” Branson said.

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