Physical and transition risk: a Pakistan-focused explainer

Physical risk arises from the physical effects of climate change. Transition risk arises from the economic and social adjustment toward a lower-carbon and more climate-resilient economy.

These are risk drivers. They affect organisations through familiar channels such as revenue, cost, asset value, credit quality, liquidity, operations, strategy and reputation.

Physical risk

Acute physical risks come from events such as floods, heatwaves, storms, droughts, landslides and wildfires.

Chronic physical risks come from longer-term shifts such as rising average temperatures, changing rainfall patterns, water stress and sea-level rise.

Examples in Pakistan can include:

• a flood disrupting production, transport, branches or supplier operations;
• heat reducing worker productivity or raising cooling and power demand;
• water stress affecting agriculture, textiles, food processing or communities;
• damage reducing collateral value or a borrower’s repayment capacity; and
• repeated events changing insurance availability, investment decisions or migration.

Transition risk

Transition risks can be driven by:

• policy and regulation;
• technology change;
• customer and buyer requirements;
• market preferences;
• energy-system change;
• litigation or liability; and
• reputational expectations.

Examples can include an exporter facing buyer emissions requirements, a lender reassessing a carbon-intensive borrower, a technology becoming less competitive or a company needing capital expenditure to meet new standards.

The risks interact

A textile business may face flood and water exposure at the same time that buyers request stronger emissions and traceability evidence. A bank may face credit losses from physical events while also financing the capital needed for adaptation and transition.

Treating the risks as isolated checkboxes can miss concentration, timing and feedback effects.

Four questions to ask

1. Which hazard or transition driver could affect the decision?
2. Through which financial, operational or social channel?
3. Over what time horizon, and with what uncertainty?
4. What evidence, action and monitoring are proportionate?

Climate risk is not only a future scenario. The task is to understand where changing physical conditions and transition dynamics already meet current decisions.

Primary sources

Use the original materials for authoritative requirements and context.

• SBP Regulatory Framework for Effective Management of Climate-related Financial Risks ↗