As climate events become more frequent and intense, inclusive FSPs are increasingly being asked to conduct Physical Climate Risk Assessments by regulators, investors, and other stakeholders.
Physical Climate Risk Assessments (PCRA) quantify how climate-related hazards (like floods, cyclones, or droughts) are likely to impact a financial institution’s portfolio and operations.
Physical Climate Risk Assessments (PCRA) quantify how climate-related hazards (like floods, cyclones, or droughts) are likely to impact a financial institution’s portfolio and operations.
Done well, PCRAs have the potential to be a significant strategic asset for inclusive FSPs grappling with the increasing threats that climate change poses. Yet our research finds that all too often they are being conducted to minimal effect, as a mere tick-box exercise; or worse, might unintentionally exclude vulnerable customers who need more, not less, support for adaptation and resilience.
This blog suggests three key questions that all inclusive FSPs should ask themselves to ensure that PCRAs are neither ‘tick-box’ nor harmful, but become strategic, proactive assets to support the FSP’s resilient evolution.
1. Why are we doing a PCRA?
Our conversations with dozens of FSPs found that they usually initiate a PCRA at the request of one of their stakeholders. Yet we found that the PCRA outcomes can differ dramatically based on the origin of the request, and that many PCRA exercises fall short of their potential for strategic impact because they only seek to respond to the requesting stakeholder, rather than assessing the full range of implications of climate risk for the organization.
The table below shows five common ways that PCRAs are kick-started and how each one can lead to potential blind spots. Practitioners should identify which scenario best correlates with their PCRA exercise and consider potential blind spots in the approach. For example, “Financial” or “Compliance” based PCRAs may miss out on considering how climate risks affect near-term field operations, while “Firefighting” or “Pragmatic” types may miss out on identifying opportunities for funding and product development based on climate risk exposure.
Whilst there is no better or worse starting point for a PCRA, being aware of the blind spots inherent in a PCRA’s origin can help organizations reduce the likelihood of missing out on strategically useful information.
2. Which stakeholders can help us make the PCRA more useful?
Once there is clear identification of the motivation for a PCRA and awareness of potential blind spots, practitioners should strengthen PCRA design by engaging a broad range of stakeholders, each with different lenses on climate risk, and incorporating their perspectives into the scope of the exercise.
Relevant stakeholders should include those inside (Board, CEO, COO, CFO, Risk, and Product) and outside (Regulator, Investor, DFI, Donor, Customer) the organization; input from this variety of stakeholders may surprise PCRA teams. For example, a DFI or Donor may want a PCRA to guide funding for a building program for customers in a flood plain, whereas the COO may want to understand which branches urgently need emergency staff plans. Whilst best to engage stakeholders at the outset of the PCRA exercise, FSPs who have already produced their PCRA reports will still benefit from revisiting these conversations and applying PCRA insights to their organization.
Notably, we found in our conversations with FSPs that the customer’s view is rarely sought out explicitly in PCRA exercises. This is a huge missed opportunity since customer perception of climate risk is critical to measure, in addition to empirical climate data, in order to design effective strategies for locally-led adaptation and resilience, and ensure that the implementation will succeed. For example, if a PCRA identifies that flood risk is high, but customers do not share that perception, flood-related interventions must take the gap into account.
3. What will we do with our PCRA?
This third question ensures that PCRA design includes a bias toward action. CGAP’s conversations with FSPs have found that PCRAs are too often filed away after completion, leading to little follow-up. Compliance-related PCRAs can be especially susceptible to inaction.
A concrete action plan is key to ensuring cross-functional engagement post-PCRA, as well as actions that are consistent with the organization’s mission. Because most PCRAs involve the Risk Department, a common concern is that PCRAs can lead to exclusion, as CGAP has previously documented, where an FSP “red-lines” vulnerable customers that a PCRA identifies as overly exposed to climate risk.
A concrete action plan is key to ensuring cross-functional engagement post-PCRA, as well as actions that are consistent with the organization’s mission.
To guard against this exclusionary outcome, a PCRA should always support a proactive approach to risk management that contributes to the FSP’s inclusive mission. Three key components are essential:
- Identify client segments – by geography, sector, and/or economic activity – who are most exposed to climate risk and therefore most in need of support.
- Identify adaptation and resilience solutions (financial instruments, information, products, and services) to reduce vulnerability, and relevant vendors and funders.
- Outline an operational contingency planning framework to reduce impact to customers and staff in the event of acute climate shocks.
Whatever the original motivation for conducting a Physical Climate Risk Assessment, its true value lies not only in its technical quality, but in its capacity to catalyze strategic change. When designed inclusively and followed by action, PCRAs can equip FSPs to protect their portfolios while deepening customer impact.
Once FSPs have crystallized the need and value for doing a PCRA exercise, there are a number of tools, some free and/or open-source, that they can use to get started. Our second blog in this series provides a guide to relevant resources and providers that inclusive FSPs can use, with a focus on increasingly available open-source tools.
