For too long, climate and environmental risks have been seen as side issues like ethical concerns, branding opportunities, or, more recently, regulatory obligations. But the truth is far more consequential: climate risks are financial risks. They are already shaping the stability of the financial system and will only become more influential as the physical and transition effects of climate change accelerate.

The Origins of a Financial Stability Concern

In 2015, then-Governor of the Bank of England Mark Carney delivered his Breaking the Tragedy of the Horizon speech—a landmark moment in reframing climate change as a systemic financial risk. He warned that by the time climate change becomes a defining issue for financial stability, it may be too late to do anything about it. The heart of the problem, he noted, lies in the mismatch of time horizons: while climate change unfolds over decades, financial decision-making operates in cycles of months or years.

Carney called attention to a fundamental challenge: traditional risk models rely on the past to forecast the future. But in the case of climate risk, the past is not prologue. Physical impacts are accelerating, transitions are unpredictable, and both are deeply interconnected. In short: history cannot guide us here.

If these risks go unnoticed or are underestimated, capital will continue to flow into high-risk assets, credit markets will misallocate funds, and insurers will underwrite vulnerabilities they don’t fully understand. Unchecked, this leads to asset bubbles, liquidity shocks, and destabilized financial institutions.

It’s Already Happening: A Case from the Real Economy

Consider what’s been unfolding in the U.S. insurance market, particularly in Florida and California. Over the past few years, increasingly frequent and intense climate events-hurricanes, wildfires, flooding-have led insurers to reassess their exposure. Major players have pulled out of high-risk areas entirely. Others have dramatically raised premiums or capped coverage.

In California, wildfires have become a regular occurrence, driven by hotter, drier conditions. The 2018 Camp Fire, linked to utility company PG&E’s infrastructure, caused over $16 billion in damages and forced the company into bankruptcy. But the repercussions didn’t stop there. Homeowners in fire-prone areas found themselves uninsured or facing prohibitively high costs. Property values fell. Mortgage lenders grew cautious. And banks, holding both mortgages and insurer exposures, suddenly had new risk on their books.

A single climate-driven event set off a chain reaction that reverberated through insurers, homeowners, lenders, investors, and finally the broader economy. What started as a natural disaster became a financial one. The system is interconnected—and increasingly fragile.

Translating Climate Risks into Financial Terms

These are not isolated stories. Around the world, risks like these are becoming systemic. A flood doesn’t just damage property—it threatens loan repayments. A sudden carbon tax doesn’t just raise prices—it renders entire business models obsolete. At the heart of the problem is translation: how do climate risks become financial risks?

Institutions like the Network for Greening the Financial System (NGFS) have mapped out these pathways. Climate risks emerge through two main channels:

• Physical risks, such as extreme weather events, rising sea levels, and chronic heat or drought, lead to damage, disruption, and loss of value.
  
  

• Transition risks, like carbon pricing, regulatory shifts, and the rapid adoption of new technologies, challenge the viability of entire industries.

But it’s the interlinkages that cause instability: climate-related events affect borrowers’ ability to repay, reduce the value of collateral, impair insurance coverage, and weaken market confidence. These impacts accumulate, accelerate, and spread—undermining financial resilience from the inside out.

Why Traditional Risk Models Are No Longer Enough

The challenge is that most financial risk models are not built to detect these vulnerabilities. They assume that historical patterns can reliably predict future outcomes. In the context of climate change, that assumption breaks down.

Climate change brings nonlinear, compounding, and long-horizon risks. Wildfire frequency doesn’t increase gradually—it spikes. Heatwaves don’t just raise temperatures—they create new weather regimes. Transition shocks don’t arrive in a smooth curve—they often come suddenly, with new laws, technologies, or social tipping points.

This makes traditional Value-at-Risk or stress testing frameworks insufficient. Without forward-looking models and scenario analysis, financial institutions are essentially driving blind—and the stakes are far too high for guesswork.

This is precisely why the Task Force on Climate-related Financial Disclosures (TCFD) was established in 2015. The idea was simple but powerful: transparency enables markets to understand and price risks. In the absence of information, markets will misprice assets, potentially sowing the seeds of future instability.

Much of the recent regulatory momentum was born from the realization that climate risks are invisible only because they’re unmeasured. TCFD laid the foundation for today’s regulatory ecosystem: from the EU Taxonomy to the CSRD and EBA/ECB guidelines on risk governance and disclosure. The goal of these frameworks isn’t bureaucracy—it’s visibility for investors, regulators, and financial institutions to detect and manage threats before they cascade. Yet, as new regulatory packages are debated and even delayed, the original rationale often gets lost.

Why This Is Now a Critical Issue for Banks

Especially in Germany, where many smaller and mid-sized banks have yet to begin assessing their climate risk exposure, there is a danger of underestimating the urgency. ESG risk is still perceived as a compliance exercise. But the implications go far beyond reporting. If climate risks are not fully embedded into credit assessments, capital planning, and strategic decision-making, institutions risk being blindsided by declining asset values, impaired borrowers, and regulatory consequences. Left unmanaged, these risks can accumulate and trigger broader financial instability.

The consequences will not remain theoretical. They will be felt in default rates, funding conditions, and ultimately in solvency metrics. Banks cannot afford to ignore these signals—not because regulators demand it, but because their own balance sheets depend on it.

A Call for Proactive Risk Management

Recognizing ESG risks as core to financial stability is not about adopting a new vocabulary—it’s about updating risk management practice. Risk professionals, CFOs, and strategy leaders must now ask: What exposures are we not seeing? What stress could our portfolio face in a 3°C world? What risks are hiding in our mortgage books, our SME lending, our investment exposures?

At Atlas Metrics, we are working to ensure that banks have the insights and tools they need to assess these risks proactively—before they become losses. Because what’s at stake isn’t just regulatory compliance. It’s the resilience of portfolios, institutions, and the financial system itself.