Climate Risks in the Financial System: An Overview of Channels, Impact and Heterogeneity

Physical damage from the effects of climate change will increase in the coming decades. However, global economies can slow this rate of increase – and potentially even reverse it – by frontloading a considerable amount of technological, infrastructural and behavioural change in the short-to medium term. Understanding such physical and transition risks for the financial system is a priority, as is the sector’s role in financing the technological transition to net zero emissions by 2050. This article presents an overview of the key climate risk transmission channels. It is likely that financial sector impacts will mainly flow though the real economy, that is, how weather/climate-related damage and net zero policies affect business and household resilience and wealth. The existing research also shows that risks are unevenly distributed across and within countries. Such heterogeneity in real-economy risks is discussed in the Irish context.