A study by the Central Bank of the UAE (CBUAE) has assessed the financial implications of climate-related disasters for the financial system, including the broader macroeconomic impact, losses from business disruptions and insurance sector spillovers.
In its “Financial Stability Report 2024”, the CBUAE said that coastal flooding posed higher tail risks due to rising sea levels, while rainfall flooding exhibited relatively lower incremental risks.
The study findings included:
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Storm Surge Risks: Losses in property valuation were estimated to range between 6% and 14%, depending on flood severity. Severe storm scenarios could raise average Loss Given Default (LGD) by up to 300 basis points, reflecting higher collateral damage and reduced recovery values.
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Capital Impact: LGD deterioration translates into higher provisioning needs, which in turn erodes capital buffers. This effect was estimated to reduce banks’ CET1 (Common Equity Tier 1) by approximately one-third of a percentage point, assuming no change in Probability of Default (PD). Additional losses could arise if PDs increase in more vulnerable segments, such as commercial real estate.
The CBUAE pointed out that climate-related financial risks are broadly categorised into:
• Transition Risk: Stemming from the shift to a low-carbon economy due to changes in policies, regulations, and market dynamics.
• Physical Risk: Resulting from climate-related events such as floods or storms, which can disrupt infrastructure, economic activity, and supply chains.
These risks can lead to asset devaluation, increased credit risks, and market volatility, potentially straining financial institutions. Left unchecked, climate risks could amplify credit, market, and operational vulnerabilities, threatening financial stability.
Recognising these challenges, the CBUAE has integrated climate risk assessments into its financial stability framework. In 2023, it conducted a bottom-up transition risk analysis to evaluate the impact of climate policy changes on individual banks. In 2024, the development focus shifted to a top-down physical risk analysis, assessing systemic financial implications of climate-related disasters. This study followed the Network for Greening the Financial System (NGFS) framework, incorporating hazard mapping, exposure evaluation, vulnerability assessment, and financial risk estimation.
Building on 2024’s top-down approach, the CBUAE plans to conduct a bottom-up physical risk scenario analysis in 2025. This exercise will focus on more granular assessments and incorporate indirect financial losses, further strengthening the integration of climate risks into financial stability assessments.