Climate change is already affecting the value of assets, the cost of doing business and the ability of borrowers to repay their loans. For African financial institutions, the challenge is no longer simply to understand climate risk, but to make it part of everyday business decisions.
Climate Risk Is Closer Than We Think
Imagine a bank financing a commercial property in Lagos. The property is valuable, the borrower has a good repayment history, and the numbers look attractive. But what happens if repeated flooding damages the building, disrupts tenants’ businesses, increases maintenance costs and reduces the property’s market value?
The borrower may struggle to repay the loan. The property securing that loan may no longer be worth what the bank originally expected. If the borrower defaults, the bank could recover less than anticipated.
Now consider a farmer facing prolonged drought, an oil and gas company dealing with rising transition costs, or a manufacturer whose operations are disrupted by extreme heat. Each situation presents a different challenge, but the financial consequences can be similar: higher costs, lower revenue, weaker repayment capacity and greater financial losses.
This is what climate risk looks like in practical terms. It is not simply about rising temperatures, environmental protection or meeting sustainability targets. It is about the money businesses make, the assets they own, the risks they carry and their ability to remain financially resilient.
Across Africa, these risks are becoming increasingly difficult to ignore. Flooding affects homes, businesses and transport networks. Drought threatens agricultural production and water availability. Meanwhile, changes in climate policy, technology and energy markets are creating new pressures for businesses that depend heavily on carbon-intensive activities.
For banks and other financial institutions, the message is clear: climate risk is also financial risk.
Why Banks Need to Pay Attention
Banks make decisions every day about who receives financing, how much they can borrow, what interest rate they should pay and what assets can serve as security. These decisions depend on an assessment of risk, including whether a borrower can repay and whether the bank can recover its money if things go wrong.
Climate change can affect both sides of that equation. There are two broad ways this happens.
Physical risks arise from the direct effects of climate change. Floods can damage buildings, factories and infrastructure. Droughts can reduce agricultural output, while extreme heat can increase energy costs and affect worker productivity. These events can interrupt business operations, reduce income and weaken the value of assets used as loan collateral.
Transition risks arise as economies move towards lower-carbon and more sustainable models. Changes in government policy, energy prices, technology, customer preferences and market expectations can increase costs or reduce demand for certain products and services. Businesses that cannot adapt may find it harder to remain competitive, attract investment or meet their financial obligations.
Consider a bank with significant lending to businesses operating in the oil and gas sector. A change in energy policy or market demand could affect some borrowers’ future revenue and the value of their assets. At the same time, a flood affecting industrial facilities in the Niger Delta could disrupt production and damage infrastructure. These are different risks, but both can influence the bank’s credit decisions.
Climate risk also extends beyond lending. Extreme weather can disrupt bank branches, offices, data centres and supply chains. Sudden changes in market expectations can affect investment values, while climate-related events may create liquidity, operational and reputational pressures.
The implication is that climate risk cannot sit exclusively within a sustainability department. It needs to be understood and managed across the organisation, particularly within credit, risk, finance, operations and investment teams.
From Global Principles to African Action
Financial regulators and standard-setters are increasingly making climate risk part of the financial management conversation. The Basel Committee on Banking Supervision has established principles for the effective management and supervision of climate-related financial risks, including the need for banks to understand how climate drivers affect their existing risk profiles.
Across Africa, regulatory approaches are also evolving. Nigeria’s Sustainable Banking Principles provide a foundation for managing environmental and social risks, while the country’s adoption of IFRS Sustainability Disclosure Standards is strengthening expectations around sustainability-related financial information. In Kenya, the Central Bank’s climate-risk guidance addresses the integration of climate considerations into governance and risk management. Ghana and South Africa have also advanced supervisory approaches to climate-related financial risks.
These developments point in the same direction: financial institutions are expected to move beyond acknowledging climate change and demonstrate how relevant risks are identified, assessed, managed and disclosed.
However, regulatory compliance is only part of the story. Understanding climate risk can also help institutions make better lending decisions, protect asset values, improve portfolio resilience and identify emerging business opportunities. The challenge is translating these expectations into everyday practice.
What Does Climate Risk Materiality Actually Mean?
The term materiality can sound technical, but the idea is straightforward:
Could a climate-related issue make a meaningful difference to a financial decision?
For a bank, that might mean asking whether flooding could reduce the value of a property used as collateral, whether higher energy costs could weaken a borrower’s cash flow, or whether changing market conditions could make a company’s business model less profitable. If the answer is yes, the risk may be financially material and should be assessed within the relevant decision-making process.
This is where climate risk connects with familiar credit risk measures.
- Probability of default (PD): Could climate-related pressures make it more likely that a borrower will fail to repay a loan?
- Loss given default (LGD): If the borrower defaults, could climate damage or declining asset values reduce how much the bank recovers?
- Expected credit losses (ECL): Should climate-related information affect the bank’s estimate of potential credit losses, where relevant under IFRS 9?
- Portfolio concentration: Does the bank have too much exposure to sectors or locations that face similar climate threats?
These questions do not mean every loan should automatically be classified as high risk because it is exposed to climate change. The objective is to identify where the risk is significant, understand how it could affect financial outcomes and respond proportionately.
Climate risk materiality is therefore not just an ESG label. It is a practical assessment of whether environmental changes could alter the numbers behind a financial decision.
Five Practical Steps Financial Institutions Can Take
Institutions do not need perfect data or sophisticated models before they begin. They can start by identifying their most significant exposures and gradually improve their assessment as information becomes available.
1. Identify Where the Greatest Risks Lie
Start by examining lending and investment portfolios. Which sectors are particularly exposed to flooding, drought, extreme heat or the transition to a lower-carbon economy? Are significant assets located in coastal or flood-prone areas? Could changes in energy policy affect particular borrowers?
The aim is to identify concentrations that could have a meaningful effect on the institution’s financial performance.
2. Understand the Borrower and the Asset
A borrower’s financial statements may not tell the entire story. Financial institutions can complement traditional credit assessments with information about the location of key assets, exposure to climate hazards, energy use, dependence on vulnerable supply chains and capacity to adapt.
For example, two businesses in the same sector may face very different levels of risk because one has resilient infrastructure and a credible adaptation plan, while the other does not.
3. Translate Climate Exposure into Financial Consequences
Identifying a risk is only the beginning. Institutions need to consider what it could mean for revenue, operating costs, repayment capacity and collateral values.
Climate scenarios can help explore how different possible futures might affect borrowers and portfolios. These are not predictions of exactly what will happen. They are tools for testing how resilient financial decisions may be under different conditions.
4. Integrate the Findings into Existing Processes
Climate risk assessments should inform relevant credit reviews, collateral valuations, lending limits, portfolio monitoring and stress testing. Where the evidence supports it, institutions may consider changes to loan conditions, risk ratings, pricing or portfolio exposures.
Climate-related information should also be incorporated into expected credit loss assessments where it is relevant and consistent with applicable accounting requirements.
5. Build the Right Skills and Accountability
Climate risk management cannot depend on one sustainability professional or department. Credit officers need to recognise how climate factors affect borrowers. Risk teams need to interpret scenarios and assess financial implications. Finance teams need to understand relevant reporting requirements, while senior management must ensure that findings influence decisions.
This requires clear responsibilities, reliable data, appropriate governance and continuous learning.
Turning Africa’s Climate Challenges into Better Decisions
Africa’s climate challenges are significant, but the continent’s response need not be limited to managing losses after they occur.
The same assessment that identifies a flood-vulnerable property can help a lender recognise the value of better drainage, resilient construction and appropriate insurance. An analysis of energy costs can reveal opportunities for efficiency and more reliable power. Assessing a business’s transition readiness can help distinguish companies that are adapting from those that may struggle as markets change.
There are opportunities in renewable energy, climate-resilient infrastructure, sustainable agriculture and resource efficiency. Financing these opportunities still requires sound commercial judgement and robust risk assessment, but understanding climate exposure can help institutions make more informed decisions about where capital is deployed.
The quality of these decisions will depend partly on the quality of the underlying information. Yet many African businesses and financial institutions still face gaps in climate data, technical expertise and practical implementation capacity.
That is why collaboration and knowledge-sharing matter. Organisations need access to credible information, relevant training, practical tools and communities where professionals can exchange experiences and learn from emerging solutions.
Platforms such as The CircularNet APP can contribute to this process by connecting sustainability and ESG professionals with knowledge, resources, training, communities and opportunities to collaborate. Building climate resilience requires more than awareness; it requires the capability to turn information into action.
The Way Forward: Make Climate Risk Part of Business as Usual
Climate risk is no longer a distant environmental concern that financial institutions can address separately from their core operations. It can influence whether a borrower remains profitable, whether collateral retains its value and whether a portfolio performs as expected.
For African financial institutions, progress does not require solving every data challenge at once. It begins with asking the right questions, identifying material exposures, using available evidence, strengthening internal capabilities and embedding relevant findings into established risk management processes.
The institutions that make this shift will be better positioned to understand emerging threats, protect financial value and identify opportunities in a changing economy.
Ultimately, the goal is not simply to report climate risk. It is to make better decisions because that risk is understood.
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