Integrating Climate Risk into Credit Risk Disclosures under IFRS 7

Credit risk is no longer limited to economic and operational factors—it is increasingly influenced by climate-related risks. For banks, financial institutions, and lenders, climate events such as floods, droughts, and regulatory shifts can significantly impact borrowers’ ability to repay loans.

Under IFRS 7 Financial Instruments: Disclosures, entities must provide detailed information on the nature and extent of risks arising from financial instruments. The IASB’s latest illustrative examples emphasize incorporating climate-related risks into these disclosures to improve decision-useful information for investors.

IFRS 7 Disclosure Requirements

IFRS 7 requires entities to disclose:

• Credit risk exposure and how it is managed.

• Information about assumptions and models used to calculate Expected Credit Losses (ECL) under IFRS 9.

• Sensitivity analysis, concentration risks, and mitigation strategies.

Now, climate risk has become a critical overlay in these assessments because environmental shifts can affect borrower solvency and asset collateral values.

IASB Illustrative Example

The IASB example highlights a financial institution managing two loan portfolios:

1. Agricultural Loans – Drought conditions increase the probability of default.

2. Real Estate Loans in Flood-Prone Areas – Collateral values may decline due to flood risk.

Key considerations:

• How climate scenarios are incorporated into credit risk models.

• Adjustments (management overlays) when historical data is insufficient for emerging risks.

• Disclosure of collateral vulnerabilities (e.g., properties in flood-prone zones) and whether risks are insured.

Insights from the Example:

• Material climate risk disclosures improve investor understanding of expected credit loss assumptions.

• Transparency about modeling assumptions and adjustments strengthens credibility.

Practical Steps for Companies

To align with IFRS 7 and emerging expectations:

1. Identify Climate-Exposed Portfolios
   Use geographic and sectoral risk mapping to determine exposure.

2. Integrate Climate Scenarios in ECL Models
   Factor in regulatory changes, weather patterns, and carbon transition risks.

3. Document and Disclose Judgments
   Explain overlays, risk-weight adjustments, and how assumptions reflect external data.

4. Highlight Risk Mitigation Measures
   Disclose use of insurance, hedging, or collateral diversification strategies.

Strategic Business Insights

Investors are increasingly scrutinizing climate resilience in financial institutions. Transparent climate-related credit risk disclosures:

• Build confidence in risk management capabilities.

• Reduce reputational risk and regulatory scrutiny.

• Support ESG commitments and align with ISSB sustainability standards.

Climate change is not just an environmental challenge—it is a financial and systemic risk that is transforming credit markets and risk assessment practices worldwide. Lenders, financial institutions, and investors are recognizing that climate-related events such as floods, droughts, wildfires, and energy transition regulations can directly impact borrower solvency, collateral values, and default probabilities. The failure to account for these risks in credit risk assessments and disclosures does not merely represent a gap in compliance; it introduces material vulnerabilities to balance sheets and investor confidence.

Institutions that neglect to integrate climate risk into credit risk disclosures face significant consequences:

• Underestimation of Expected Credit Losses (ECL): Without incorporating climate-driven variables, ECL models may underestimate impairment losses, resulting in distorted financial results and potential regulatory penalties.

• Reputational and Market Risks: Stakeholders, including investors and regulators, increasingly demand transparency on climate-related exposures. Opaque disclosures can erode trust and limit access to capital.

• Strategic Misalignment: Failure to address climate risk undermines ESG goals and exposes businesses to competitive disadvantages in an era of sustainability-focused capital allocation.

The IFRS 7 framework, reinforced by the IASB’s latest guidance, empowers institutions to deliver decision-useful disclosures that highlight:

• How climate risks influence credit exposures.

• The incorporation of these risks into ECL modeling under IFRS 9.

• Risk mitigation strategies, including insurance coverage, portfolio diversification, and scenario-based stress testing.

Why This Matters for Your Business

Integrating climate considerations into credit risk disclosures is more than a compliance task—it is a strategic lever for resilience and growth. Companies that demonstrate robust climate risk integration:

• Strengthen investor confidence by showcasing advanced risk management capabilities.

• Improve regulatory readiness as disclosure expectations converge under IFRS and ISSB frameworks.

• Unlock competitive advantages in attracting ESG-focused capital and customers.

How Dawgen Global Can Help

At Dawgen Global, we specialize in transforming these challenges into opportunities through:

• Climate Risk Integration into Credit Models: We work with your teams to embed environmental and transition risk factors into existing credit risk frameworks.

• Disclosure Strategy Development: Align financial reporting with IFRS 7, IFRS 9, and ISSB sustainability standards for seamless compliance and stakeholder clarity.

• Advanced Risk Analytics & Scenario Modeling: We help institutions model the impact of various climate scenarios on credit portfolios, enabling proactive decision-making and enhanced resilience.

Final Thought

In a financial landscape where climate resilience is fast becoming a benchmark for credibility, integrating these risks into credit disclosures is not just a regulatory requirement—it is a hallmark of sound governance and strategic foresight. Businesses that act now will not only meet compliance obligations but position themselves as leaders in sustainable finance and responsible risk management.

Next Step!