Managing Climate-Driven Financial Risks Within Existing Regulatory Frameworks

The IMF says financial regulators must treat climate change as a source of real financial risk, integrating it into existing supervisory frameworks to protect stability and market integrity. However, they should stay within their core mandates and avoid using regulatory tools to drive climate policy or green investment.

Climate change is no longer just an environmental issue. It is now a financial one. A recent paper by the International Monetary Fund explains how banks, insurers, and capital market regulators should deal with climate-related risks without stepping outside their legal responsibilities. The study draws on the work of global bodies such as the Basel Committee on Banking Supervision, the Financial Stability Board, the International Association of Insurance Supervisors, the International Organization of Securities Commissions, the International Sustainability Standards Board, and the Network for Greening the Financial System. Together, these institutions are shaping the global response to climate risks in the financial sector.

The IMF’s message is straightforward. Financial regulators must protect stability and market integrity. They are not climate policymakers. Their job is not to force banks to lend to green projects or to replace government climate policies. Instead, they must ensure that financial institutions understand and manage climate-related risks when those risks are significant.

Why Climate Risk Is Financial Risk

Climate risks affect money in very real ways. Physical risks, such as floods, wildfires, and storms, can damage homes, factories, and infrastructure. This can reduce property values and make it harder for borrowers to repay loans. Insurance companies face rising claims from natural disasters.

There are also transition risks. As countries move toward cleaner energy, new laws, carbon pricing, and changing consumer preferences can affect businesses. Companies that depend on fossil fuels or carbon-heavy processes may lose value. Investors and lenders exposed to these companies may face losses.

In addition, climate-related lawsuits are on the rise. Firms and even their directors can be sued for failing to manage or disclose climate risks properly. All of this can affect banks, insurers, and investors through traditional financial channels such as credit risk, market risk, and operational risk.

Staying Within the Mandate

The IMF stresses that regulators must stay focused on their core responsibilities. Banking and insurance supervisors are meant to ensure the safety and soundness of institutions. Securities regulators must protect investors and keep markets fair and transparent.

If climate risks are material, meaning they could seriously affect financial stability or market integrity, then supervisors must address them. Ignoring such risks would be irresponsible. However, using regulatory tools to promote green lending or punish certain industries goes beyond their mandate and could create unintended problems, such as weakening capital buffers or distorting markets.

The report encourages a balanced, evidence-based approach. Supervisors should first assess how exposed their financial system is to climate risks. Decisions should be guided by data, not political pressure or public opinion.

Using Existing Tools, Not Reinventing the System

One key point is that regulators do not need an entirely new rulebook. Existing supervisory frameworks are already designed to manage changing risks. Climate risks can be integrated into current processes such as risk assessments, stress testing, and supervisory reviews.

For banks, this may mean mapping exposures to climate-sensitive sectors and using scenario analysis to test how portfolios would perform under different climate pathways. Supervisors can require better governance, stronger risk management, and clearer reporting where weaknesses are found.

The IMF advises caution when it comes to changing capital requirements. There is not yet enough solid evidence to justify lower capital charges for “green” assets or higher ones for “brown” assets. Until better data and methods are available, supervisors should rely on existing review tools rather than rushing to rewrite capital rules.

In insurance, supervisors must pay close attention to rising disaster losses and the availability of reinsurance. Climate change can affect both underwriting risk and long-term investment portfolios. Legal risks linked to climate litigation are another emerging concern.

In capital markets, regulators are focusing on better climate-related disclosures. Global sustainability reporting standards are helping improve consistency. At the same time, regulators are working to prevent greenwashing, where financial products are marketed as environmentally friendly without solid backing.

A Special Challenge for Emerging Markets

Emerging market economies often face higher climate vulnerability but have fewer supervisory resources. The IMF recommends that these countries carefully assess whether climate risks are truly material to their financial systems.

If risks are limited, strengthening basic supervisory capacity should come first. Weak regulatory foundations cannot be fixed simply by adding climate rules. But where climate risks are significant, they must be built into the core supervisory framework from the start.

The overall conclusion is pragmatic. Climate change is reshaping financial risk, and regulators cannot ignore it. Yet they must respond carefully, using existing tools, relying on solid data, and staying within their legal mandates. By doing so, they can help ensure that financial systems remain stable and trustworthy in a warming world.