Assessing and Treating Physical Property Risk: Lessons from the Bank of Canada's Climate-Related Risks Disclosure 2022
Climate change is no longer a distant possibility; it is an ever-present reality that poses significant risks to physical property, financial stability, and economic well-being. The Bank of Canada’s first annual climate risk disclosure report for 2022 lays a strong foundation for understanding and managing these risks, especially those related to the physical impacts of climate change. While the Bank's primary focus is not climate policy, it acknowledges the need to understand the implications of climate change to fulfill its mandates effectively. This blog post aims to elucidate key points in assessing and treating physical property risk, drawing inspiration from the Bank of Canada’s disclosure.
Types of Risks
According to the Bank of Canada, climate risks can be broadly categorized into:
Physical Risks: The direct physical impacts of climate change, like natural disasters and extreme weather events that lead to loss of property and disruptions in economic activities
Transition Risks: These are the financial risks that result as the economy transitions to a greener, low-carbon model. This transition could be disruptive and affect asset valuations and financial stability.
Assessing physical risks
1. Increased Frequency and Severity
Extreme weather events are becoming more frequent and severe. This includes floods, wildfires, and storms that cause substantial damage to homes, businesses, and infrastructure. Effective risk assessment starts with acknowledging this new baseline in weather-related risks.
2. Economic and Supply Chain Impacts
Physical risks are not confined to the loss of physical property alone. They can create negative supply shocks like the destruction of capital stocks and disruptions to labour and supply chains. This, in turn, can influence the economic forecasts that central banks and financial institutions rely on, including output gaps and inflation.
3. Data Collection and Modelling
To better understand how climate change might affect the country's economy, the Bank of Canada is investing in climate models. Quantifiable metrics can help institutions assess their current and future exposure to these risks.
Treating physical risks
1. Building Resilience
Adaptation strategies to build resilience could involve retrofitting buildings to withstand extreme weather, investing in flood barriers, and creating more resilient supply chains.
2. Business Continuity Planning
The Bank of Canada is focused on building resilience and strengthening business continuity, especially in critical areas such as monetary policy and supplying bank notes to Canadians. Organizations should similarly have robust plans in place for continuity in operations following a physical risk event.
3. Energy Efficiency and Emission Reduction
The bank has a strategy to reduce the environmental impact of its physical operations. This includes transitioning to renewable energy sources and implementing approaches to reduce energy use. By doing so, organizations can also mitigate the extent of climate change, thus lowering future physical risks.
4. Financial Measures
Understanding the financial implications of physical risks allows for better insurance coverage and asset management. Institutions must transparently disclose their risk assessments and treatment methods, which can also enable better investment decisions.
5. Partnerships
Collaborative efforts between the private and public sectors can aid in a more comprehensive approach to mitigating risks. The Bank is working with the Office of the Superintendent of Financial Institutions and the private sector to assess physical and transitional risks related to climate change.
Inclosing…
Physical risks due to climate change are increasingly integral to financial and economic stability. The Bank of Canada’s disclosure underscores the importance of understanding, assessing, and treating these risks to safeguard our economic and financial well-being. It’s time for risk management professionals, financial institutions, and organizations at large to recognize this urgency and take steps to mitigate the effects.