Global regulators[1] are increasingly emphasizing the need for forward-looking, long-term planning in assessing climate-transition risks. For example, the European Banking Authority's latest guidance on managing ESG risks requires banks to extend their risk horizons to at least 10 years, recognizing that climate risks often take decades to materialize. Lenders need to understand how transition risks transmit to credit, market and liquidity exposures. Advanced tools like climate-scenario analysis and stress testing are therefore becoming essential for shaping risk appetite and capital planning at credit institutions. In this blog post, we explore how banks can leverage these tools to meet evolving regulatory demands.
Banks' exposure to climate-transition risks: Insights from regional loan books
Based on the commercial loan books of lenders within MSCI ESG Ratings coverage, we identified a representative sector breakdown of credit institutions across Europe, the Americas and the Asia-Pacific (APAC) region.[2]
APAC had the highest carbon-intensive exposures (61%), largely driven by industrials (50%). In Europe, carbon-intensive sectors made up 29% of loan exposures, while in the Americas, they accounted for 31%.[3] Notably, the Americas also had the highest energy exposure at 1.82%, though this remained marginal across all regions.
Representative loan-book exposures by sector and region
Data as of December 2024. The analysis is based on credit institutions under MSCI ESG Ratings coverage classified within diversified banks, regional banks, diversified financial services and diversified capital markets, across three key regions. Source: MSCI ESG Research
Expected changes in probability of default due to climate-transition risks
To understand the financial impact of climate-transition risks on loan books, we applied the MSCI Climate-adjusted Probabilities of Default (PD) model to the regional loan-book exposures. We compared the results against our model's "conventional PD baseline," which excludes transition-risk factors, across relevant sectors.[4] By modeling a 2 degrees C disorderly transition scenario[5] for three time points of the term structure, the findings shed light on the evolving climate-adjusted credit-risk landscape for banks in the different regions.
Our analysis showed that, in the short term, the impacts of transition risks remained moderate across the three regions, reflecting the inertia of economic adjustments. By year 10 of the term structure, however, the climate-adjusted PD of a typical commercial loan book in APAC increased by 50%, surging to 114% by year 15. This was primarily driven by the portfolio's significant exposure to the industrials sector, including carbon-intensive activities such as construction, machinery and transportation. In contrast, the representative European loan book, with significant exposure to the financial sector (31%) and a more modest contribution from industrials (22%), experienced lower climate-adjusted impacts, with PDs rising by 22% at year 10 and 50% at year 15. Similarly, the Americas loan book, which closely resembled Europe's composition, saw PD increases of 19% at year 10 and 46% at year 15.
Rise in credit risk under a 2 degrees C disorderly transition
Data as of December 2024. The graph shows the percentage difference over baseline risk for EVIC-weighted aggregated forward probabilities of default which account for transition risks, including greenhouse-gas emissions from scopes 1, 2 and 3 at years five, 10 and 15 into the term structure. These scenario-based modeling results are based on a 2 degrees C NGFS disorderly-transition scenario. To estimate changes in credit risk, MSCI employs a Black-Cox model with a distance-to-default to probability of default mapping calibrated on historical bond defaults. For additional methodological insights, please refer to: "Introduction to Climate-Adjusted Probabilities of Default," MSCI ESG Research, August 2023 (client access only). Source: MSCI ESG Research
When the model assumptions were adjusted to all future climate costs being priced in immediately — rather than over a five-year forward rolling horizon — the impacts surged dramatically, increasing credit risk by ~160% to 330% across the term structure under a 2 degrees C disorderly scenario.[6]
How are banks managing transition risks in different regions?
Only a minority of credit institutions publicly reported implementing advanced practices for managing transition risks. Among those under MSCI ESG Ratings coverage with significant lending activities, only 21% disclosed evidence of conducting sensitivity analyses on their businesses and/or balance sheet to assess climate-related impacts using climate scenarios or similar methodologies.[7] Nevertheless, at a regional level, we found that these practices were more established in APAC (37%) and Europe (23%), whereas the Americas (7%) was a significant laggard.
Separately, only 18% of credit institutions in selected regions reported integrating climate-related factors into risk management or financial decision-making processes.[8] These practices include incorporating climate-specific factors in due diligence, applying internal carbon-price mechanisms and using decarbonization targets to inform lending decisions, portfolio allocation and monitoring. European institutions outperformed in this category, with 27% disclosing such practices. This aligns with the findings of a European Central Bank (ECB) working paper, which showed that, on average, EU banks charge clients with the highest carbon emissions 14 basis points (bps) more in monthly interest rates, and an additional 20 bps for those lacking plans for emissions reduction.[9]
Risk-management practices of credit institutions to climate-related risks
Data as of December 2024. The analysis is based on MSCI ESG Ratings' Financing Environmental Impact Key Issue, applied to assess companies with significant lending and underwriting operations. Source: MSCI ESG Research
What does this mean for credit institutions?
As transition risks intensify and regulatory expectations tighten, integrating transition risks into credit-risk assessment are becoming increasingly important. Differences in sector exposures identified in this analysis underscore the need for tailored risk-management strategies. Climate-adjusted PD models can help banks better identify and mitigate transition risks through climate-aware policies around credit risk. By embedding transition-pricing dynamics into credit frameworks, banks can further strengthen their risk-management capabilities and enhance long-term resilience.
The authors would like to thank Julia Sulc and Raphael Klein for their contributions to this blog post.
