Executive summary

Contemporary climate policy and finance discourse frequently collapses various categories of climate risk into a single concept. This conflation blurs institutional mandates and tools, leading to real consequences such as misplaced expectations and the politicisation of technical functions. The report identifies that institutions are often pressed to deliver outcomes they do not control, while critical responses are crowded out by misplaced expectations. This paper provides analytical clarity across three dimensions: three distinct types of climate-related risk, six types of response, and the specific institutional mandates required to deliver those responses. Getting these distinctions right is considered a precondition for coherent climate governance.

Three types of climate-related risk

Climate change generates three distinct risk categories that must not be conflated. Planetary risk refers to the physical hazard itself, including rising temperatures and extreme weather events, much of which may never appear in economic measures. Economic risk is the subset of physical and transition impacts that reduce output, livelihoods, and public budgets. Financial risk is a further subset that impairs credit quality, portfolio values, and balance sheets, potentially threatening financial system stability. Conflating these produces unmanaged vulnerabilities and perverse outcomes, as each category demands different responses from different institutions.

Six distinct responses to climate-related risk

Six responses address climate-related risk at different layers. Mitigation reduces the underlying planetary hazard by decarbonising energy and industrial systems; it is the only response that reduces the scale of risk all others must manage. Resilience reduces economic and social vulnerability through infrastructure and ecosystems. Risk sharing absorbs and allocates financial losses through insurance and capital markets. Fiscal resilience preserves a government’s capacity to finance disaster response and stabilization over time. Exposure management limits institutional financial losses by adjusting underwriting and portfolio allocation, though this often shifts the burden elsewhere. Finally, financial system stability prevents correlated failures and sustains credit flows as shocks propagate through the economy.

Why analytical clarity matters for different policy objectives and institutional mandates

Different institutions operate under distinct legal mandates and time horizons. Analytical clarity allows each to identify what it can realistically deliver and prevents the recurring pattern of expecting institutions to deliver outcomes exceeding their authority. The report argues that climate advocacy has often placed expectations on institutions that exceed their instruments, while those with the correct mandates often lack the focus to deploy them effectively.

Banking and credit provision: managing financial exposure

The primary objective for banks is to manage material risks to credit quality and balance-sheet soundness over horizons typically extending less than a decade. Lending decisions are based on near-term indicators rather than long-term climate trajectories that banks cannot control. Prudent credit risk management often leads to increased borrowing costs and shorter loan tenors in climate-vulnerable regions. While this protects the individual bank, it can cumulatively tighten financing precisely where mitigation and adaptation needs are most acute. Banks can contribute to transition finance by resolving discrete bottlenecks through project finance and risk-sharing arrangements rather than by incorporating long-term planetary risk into credit spreads.

Investing: preserving asset and portfolio value

Investors are mandated to maximise risk-adjusted returns within fiduciary obligations. Asset managers can only allocate capital to assets that exist in investable form; they cannot override mandates for climate commitments without breaching their duties. Secondary market transactions, such as divestment, simply shift exposure between investors without changing real-economy emissions. The report notes that portfolio alignment frameworks often lead to ‘paper decarbonisation’ rather than real-world emissions reductions. Investors’ most consequential contribution is working with public and private actors to resolve structural constraints that limit capital flows to specific projects.

Insurance and risk sharing: allocating and absorbing losses

Insurance mechanisms allocate financial losses to stabilise households and firms but cannot prevent physical damage or substitute for land-use decisions. Private insurance is most effective where risks are diversifiable; as climate impacts intensify and risks become more correlated, private insurers may withdraw or raise premiums. This retreat has consequences for mortgage markets and local fiscal bases. Public policy should focus on reducing underlying exposure through resilience investment rather than expecting insurers to underwrite uninsurable risks.

Macroeconomic authorities: monetary and financial stability

Central banks focus on maintaining aggregate stability, sustaining credit flows, and anchoring inflation expectations. While they can deploy liquidity facilities to absorb shocks, these tools cannot determine the trajectory of underlying physical risks or the pace of transition. Financial stability can coexist with rising public debt and degraded ecosystems, so stable financial indicators are not a proxy for well-managed climate risk.

Supervisors: ensuring prudential safety and soundness

Financial supervision aims to ensure the safety of regulated institutions regarding capital adequacy and liquidity. Stress testing is a diagnostic tool that reveals potential losses under defined scenarios; it is not an instrument for transition planning. Expecting stress tests to drive decarbonisation can lead to unintended consequences, such as tightening finance in sectors where it is most needed for adaptation. Clarity on these boundaries prevents microprudential mandates from drifting into objectives supervisors are not equipped to deliver.

Fiscal authorities: deploying public instruments and managing trade-offs

Governments bear the unique responsibility for acting across the full range of responses, including providing public goods like resilience infrastructure and social protection. Fiscal authorities hold instruments like public investment, carbon pricing, and sovereign guarantees. They are uniquely positioned to define decarbonisation pathways and manage the trade-offs between competing fiscal demands. The report suggests that climate policy formation has drifted toward central banks and supervisors, leaving fiscal authorities underdeployed on the critical decisions only they can make.

Conclusions

Disentangling climate-related risks allows for a more effective matching of institutional expectations with regulatory requirements. Confusion has impeded the financing of decarbonisation by loading financial institutions with unmandated expectations and allowing fiscal liabilities to accumulate without coherent management. Coherent governance depends on aligning institutional mandates and tools across both public and private sectors with the specific risks each is positioned to address.