Climate risk buffer needed to mitigate banks’ climate change losses, says nonprofit

It’s been 10 years since Canadian prime minister Mark Carney made his landmark speech on the tragedy of the horizons when he was governor of the Bank of England. Despite increased information and awareness, financial markets have not effectively priced climate risks, a leading climate nonprofit says.  

Banks had more than USD$1.1tn in exposures to fossil fuels on their balance sheets in 2023, or USD$1.6tn if off-balance sheet exposures are included, a new report from Finance Watch found.

These assets are not only contributing to climate-related physical risks, but are also subject to transition risk. That’s why there’s a need for a systemic climate risk buffer, said Julia Symon, head of research and advocacy at Finance Watch and one of the authors of the report.

“We clearly see that we need to go from soft informational measures to more prescriptive policy measures…We need to price in that risk across the board via regulation, because financial markets are incapable of themselves organising and recognising that risk”.

Financial institutions generally look at one-year to three-year time frames, especially regarding risk. Carney’s speech urged institutions to instead look at a longer time frame of at least 10 years to account for climate change risks. 

But that decade has come and gone and banks are still not using a forward-looking model, said Symon.

“They’re not capturing these longer time horizons, radical uncertainty, the buildup of systemic risk. So all of these mechanisms at the end, they work in a way that the climate risk remains unconsidered,” she said.

Banks still exposed to fossil fuels

The total balance sheet exposures to fossil fuels was highest in Asia Pacific, at USD$1.079tn, followed by Europe (including the EU, UK and Switzerland) at USD$293bn and the US at US$269bn. A separate report shows that fossil fuel financing soared in 2024 to US$869bn.

 Various reports from leading economists and climate scientists have shown that not transitioning to a green economy could result in higher bank losses due to their exposure to carbon-intensive industries. Meanwhile, data and methodology challenges have led to deficiencies in how banks manage their climate risk, the report states.

 A climate risk buffer would help prevent a potential financial crisis from bank exposures to fossil fuels.

 “The objective of the climate buffer would be to prevent the further buildup of risk right into the future,” Symon said.

 While capital buffer frameworks vary by jurisdiction, implementing a climate buffer would be in a central bank’s mandate, she said.

 In the EU, for example, a systemic risk buffer already exists that can be used by nation state central banks to address climate risk, although so far no national banks have implemented such a buffer. Symon said she’d like to see it implemented on a wider EU level at the European Central Bank.

 “The ECB has already introduced a climate score for their monetary policy operations, which means that they’ve already made the step to saying this is the risk and it can be done,” she said.

 Symon said that “information remains essential” on climate change risk and exposures is still needed, as some jurisdictions like the US don’t reveal the full exposure of their balance sheets.

“We know that the longer we delay the transition the more disorder [there] is going to be and also in the meantime, the systemic risk due to physical climate change is also growing,” she said.

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