How climate-related risks reshape financial system resilience and why sustainable finance has become essential for safeguarding long-term stability?
Introduction
Climate change has become one of the most significant structural challenges confronting modern economies and financial systems. Rising temperatures, more frequent and intense extreme weather events, biodiversity loss, and accelerated environmental degradation are reshaping economic activities, altering risk profiles, and creating new transition pathways. For financial systems, these developments are no longer abstract, long-term ecological concerns—they are real, material risks influencing credit quality, capital allocation, liquidity conditions, and overall systemic resilience.
In this evolving context, sustainable finance has emerged as a critical framework that integrates Environmental, Social, and Governance (ESG) considerations into financial decision-making. Its goal is twofold: to strengthen the ability of financial institutions to withstand climate-related and other ESG risks, and to mobilize capital toward activities that support a greener, more inclusive, and more resilient economy.
Globally, central banks and financial supervisory authorities have recognized this dual objective. Georgia is no exception. Through the leadership of the National Bank of Georgia (NBG), the country has become an active contributor to sustainable finance developments, adopting ESG frameworks, introducing regulations, policies, guidelines, and tools aimed at establishing the foundations of a sustainable financial ecosystem.
This article explores how sustainable finance acts as a pillar of financial stability in the era of climate change. It examines the nature of climate-related financial risks, the regulatory and supervisory responses, the importance of ESG integration, that support a resilient transition.
Climate Change as a Financial Stability Challenge
Ongoing climate change represents the most critical among environmental risks, exerting a significant influence on financial stability. Before the Paris Agreement (December 2015) on Climate Change, leading financial institutions were already preparing to take greater responsibility for managing climate and broader ESG risks by integrating them into their strategic planning and risk-management processes—a shift powerfully accelerated by Mark Carney’s speech[1] at Lloyd’s of London. As Governor of the Bank of England and Chair of the Financial Stability Board (FSB), Carney spoke from two of the world’s influential financial authorities, giving his warnings unique global weight. Delivering the speech at Lloyd’s, a historic center of insurance and risk expertise, further underscored the financial sector’s growing recognition that climate change posed material threats to stability rather than distant environmental concerns. This combination of authoritative voice and symbolic venue elevated climate and ESG risks onto the global financial agenda in the months leading up to COP21, helping set the intellectual and policy foundation for today’s sustainable finance frameworks.
Mark Carney’s 2015 speech at Lloyd’s of London addresses the mounting systemic risks posed by climate change and argues that these risks are unprecedented in scale and nature. Speaking shortly, Carney highlighted the accumulating scientific evidence showing rising temperatures, record levels of greenhouse gases, and accelerating sea-level rise. He emphasized that climate-related disruptions were already quantifiable, noting the tripling of weather-related loss events since the 1980s and a fivefold increase in associated insurance losses. These observations provided the foundation for his central argument: climate change is not a distant environmental issue but a present and growing financial stability concern. [2]
Carney introduced the influential concept of the “Tragedy of the Horizon,” explaining that climate risks unfold over time horizons that significantly exceed the planning cycles of firms, policymakers, and regulators. Because the most severe effects lie beyond typical business, political, and financial cycles, the current generation lacks sufficient incentives to mitigate the problem, despite creating most of the risks. He warned that by the time climate change becomes a defining financial stability threat, it may be too late for an orderly response. This framing underscored the urgent need for forward-looking analysis and long-term risk management in financial markets.
The speech further outlined three channels through which climate change can affect financial stability: physical risks, liability risks, and transition risks. Physical risks include direct damage from climate-related events; liability risks arise when parties seek compensation for losses linked to climate change; and transition risks emerge from abrupt shifts toward a low-carbon economy. By delineating these channels, Carney provided one of the earliest comprehensive frameworks for assessing climate-related financial risks—an approach that later influenced emerging sustainable finance regulations, disclosure standards, and risk management methodologies worldwide.
Carney’s intervention was significant because it helped to catalyze the development of sustainable finance as a distinct field. The speech laid intellectual groundwork for initiatives such as the Task Force on Climate-related Financial Disclosures (TCFD), which Carney supported as Chair of the Financial Stability Board. His arguments encouraged regulators, investors, and insurers to integrate climate considerations into governance, risk assessment, and strategic planning. By framing climate change as a financial—rather than purely environmental—issue, Carney accelerated global recognition that climate risks must be embedded in financial system oversight. Building on this shift in global understanding, the relationship between financial stability and a sustainable finance framework becomes essential to explain how climate and broader ESG risks are now embedded at the core of modern financial regulation and supervision.
Financial Stability and Sustainable Finance Framework
Financial stability and a sustainable finance framework are deeply interconnected, reinforcing one another across risk management, capital allocation, and long-term economic resilience. A sustainable finance framework strengthens financial stability by ensuring that ESG and climate-related risks—now widely recognized as material financial risks—are systematically integrated into decision-making across the financial system. At the same time, a stable and well-regulated financial system is essential for mobilizing the large-scale, long-term investments required to meet sustainable development and climate objectives.
Financial stability refers to a condition in which the financial system—including banks, markets, and other institutions—can withstand shocks, continue to provide credit and payment services, and support economic activity without disruption. A stable system effectively manages risks, maintains confidence, and prevents systemic crises. In contrast, a Sustainable Finance Framework embeds Environmental, Social, and Governance (ESG) considerations—including climate and nature-related risks—into financial decision-making. Its purpose is both to manage ESG-related risks and to reorient capital flows toward environmentally and socially beneficial activities.
In practice, sustainable finance serves two core functions: risk mitigation and sustainable capital allocation. A key component of sustainable capital allocation is the use of structured approaches—such as sustainability taxonomies—which guide investment toward environmentally and socially beneficial activities, and these mechanisms will be explored in the next article. The risk mitigation requires financial institutions to assess how ESG factors, especially climate-related risks, affect their portfolios and business models. By accurately pricing climate and other ESG risks, the financial system becomes inherently more stable. Sustainable finance contributes to this stability by reducing exposures to climate-sensitive sectors, improving forward-looking risk assessment through scenario analysis, enhancing transparency via sustainability reporting, promoting diversification toward resilient industries, and supporting an orderly transition that minimizes abrupt market corrections. As a result, sustainable finance creates stronger alignment between financial sector performance and long-term societal well-being.
ESG risks themselves arise through multiple channels. Physical climate risks stem from acute events—floods, storms, heatwaves—and chronic environmental changes such as rising temperatures, water scarcity, soil degradation, and altered precipitation patterns.[3] These can disrupt economic activity, damage infrastructure, impair asset values, and weaken household and corporate resilience. For banks, these physical shocks translate into credit risks (borrowers unable to repay loans), market risks (declining collateral values), and operational risks (business disruption, increased costs).
Transition risks result from the global shift toward low-carbon economic models driven by policy changes, technological innovation, and evolving market preferences. Carbon-intensive sectors face heightened pressures, including stranded assets and profitability declines, especially under rapid or disorderly transitions. Social and governance factors—such as labor rights, community impacts, supply chain resilience, board oversight, and ethical conduct—further influence financial resilience by shaping reputational risk and long-term performance.
Figure 1 – Climate-Related Risks, Opportunities, and Financial Impact (TCFD)
The diagram illustrates how climate-related risks and opportunities translate into financial impacts by affecting an organization’s strategic planning, risk management, and ultimately its financial statements. Transition risks—such as policy changes, technological shifts, market dynamics, and reputational pressures—and physical risks—both acute events and chronic changes—feed into a company’s overall exposure. At the same time, climate-related opportunities, including resource efficiency, new energy sources, innovative products and services, market expansion, and resilience-building, also shape strategic responses. These combined risks and opportunities influence financial performance through changes in revenues, expenditures, assets, liabilities, and financing needs, which are ultimately reflected in the income statement, cash flow statement, and balance sheet.
Given these complex and interrelated risks, financial systems increasingly require harmonized approaches to transparency, measurement, and disclosure. This need has led to the emergence of international ESG and sustainability reporting standards, such as the Task Force on Climate-related Financial Disclosures (TCFD), created by the Financial Stability Board (FSB), developed a global framework for companies to mainstream and disclose climate-related financial risks. Its recommendations focus on four pillars: Governance, Strategy, Risk management, and Metrics and targets.[4] Governance addresses the board’s and management’s oversight of climate issues; strategy requires disclosure of actual and potential impacts of climate risks and opportunities on business models and financial planning; risk management focuses on the processes used to identify, assess, and manage climate-related risks; and metrics and targets ensure organizations report the indicators and goals they use to evaluate performance in managing climate-related risks and opportunities. These four elements form the foundation for transparent, decision-useful reporting that enables investors and stakeholders to assess how effectively an organization is responding to climate-related financial risks.
TCFD became the global benchmark for climate reporting and served as the foundation for International Financial Reporting Standards – Sustainability Standard 2: Climate-related Disclosures (IFRS S2) developed by International Sustainability Standards Board (ISSB). In 2023, the FSB formally transferred monitoring of TCFD to the ISSB, acknowledging that IFRS S1 and IFRS S2 fully incorporate and build upon the TCFD framework. TCFD’s core pillars—Governance, Strategy, Risk Management, Metrics & Targets—continue unchanged under ISSB. This alignment is explicitly stated in IFRS S1 and IFRS S2, which require disclosures structured around TCFD’s architecture.
Complementing TCFD/ISSB, the Taskforce on Nature-related Financial Disclosures (TNFD) expands the focus beyond climate to cover nature-related dependencies, impacts, risks, and opportunities. It helps institutions understand how issues such as biodiversity loss, deforestation, and ecosystem degradation can influence financial performance.
European Sustainability Reporting Standards (ESRS) mandatory sustainability reporting standards adopted under the EU’s Corporate Sustainability Reporting Directive (CSRD) integrates both financial materiality and environmental or social impact (“double materiality”) and covers a wide range of topics—from climate and pollution to human rights and governance. Double materiality ensures a holistic understanding of sustainability performance, capturing both: how sustainability issues influence the company (Outside-in Perspective), and how the company influences society and the environment (Inside-out Perspective). In essence, double materiality provides a more complete picture of a company’s sustainability footprint and resilience, supporting better decision-making by investors, regulators, and stakeholders. The Basel disclosure framework (Pillar 3 for climate-related financial risks) complements the ESRS by shifting the focus to financial system stability, specifically targeting banks’ exposure to climate risks. While ESRS captures the company’s impact on society, Basel mandates banks to disclose how climate change (physical and transition risks) influences their asset quality, capital adequacy, and overall solvency. This ensures that the financial sector proactively manages the “outside-in” sustainability risks that could threaten global financial stability.[5]
Together, these global frameworks form an interconnected ecosystem that improves transparency, comparability, and accountability, enabling financial systems worldwide to manage ESG risks more effectively and support a more sustainable economy. These standards provide a consistent basis for identifying, quantifying, and disclosing ESG and climate-related risks, enabling financial institutions to integrate sustainability considerations more effectively and ensuring that markets operate with clear, comparable, and decision-useful information.
Sustainable Finance Framework of Georgia: A National Example
Over the past decade, the National Bank of Georgia (NBG)[6] has emerged as a regional frontrunner in sustainable finance by establishing a comprehensive policy and supervisory framework designed to integrate (ESG) considerations into the core of financial sector development. This framework is structured around four core and two supportive pillars—sustainable finance flows; ESG integration and risk management; transparency, reporting and data; greening the national bank of Georgia; awareness and capacity building; local and international coordination and partnership—each of which addresses a critical dimension of financial system resilience in the context of climate change and evolving sustainability challenges. Collectively, these pillars reflect NBG’s long-term vision of aligning the Georgian financial system with global standards while supporting national sustainability objectives.[7]
One of the central elements of this framework is the introduction of ESG Guidelines and strengthened corporate governance requirements. Developed through a double materiality lens, the ESG Guidelines instruct financial institutions to identify ESG risks and opportunities, integrate them into strategic planning, and conduct ESG due diligence at both loan and portfolio levels. By embedding ESG responsibilities within the mandates of supervisory boards and management bodies, NBG ensures that sustainability issues are treated as strategic considerations rather than peripheral concerns. Commercial banks and microbanks are therefore required to institutionalize ESG risk management practices, ensuring that sustainability considerations shape credit decisions, stakeholder engagement, and long-term corporate strategy.
NBG’s Climate Stress Testing Framework[8] represents a major advancement in assessing climate-financial vulnerabilities, offering Georgia its first fully integrated system for evaluating the resilience of banks to both physical and transition risks. The framework incorporates specialized analytical modules tailored to acute physical risks—such as heatwaves, extreme precipitation, and strong winds—as well as chronic and transition risks arising from long-term temperature increases, carbon pricing, and structural shifts toward a low-carbon economy. Using a combination of input–output modeling, mixed endogenous–exogenous approaches, and NGFS-aligned scenarios, the framework quantifies climate impacts on GDP, macrofinancial indicators, borrower repayment capacity, sector-specific NPL ratios, and bank capital adequacy. The framework enables regulators and financial institutions to better understand where climate risks may create system-wide vulnerabilities and how capital buffers can be managed to maintain financial stability in a changing climate.
Complementing these risk assessment tools, the Georgian Sustainable Finance Taxonomy[9] establishes a unified classification system for environmentally sustainable activities. By aligning with international taxonomies and principles, the Georgian taxonomy promotes consistency in green lending and sustainable investment practices. It provides clarity to market participants on which activities qualify as environmentally beneficial, thereby reducing the risk of greenwashing and enabling more accurate performance measurement, monitoring, and reporting.
NBG has also taken active steps to stimulate the development of sustainable finance markets and instruments. Through regulatory incentives and capacity-building initiatives, it encourages the issuance of green, social, and sustainability bonds, supports the creation of sustainable lending products, and promotes methodologies for assessing financed emissions. The development of ESG data infrastructure and standardized reporting systems further contributes to market maturity by enhancing transparency and improving the availability of decision-useful information. These initiatives help mobilize capital toward clean energy, green buildings, circular economy solutions, sustainable agriculture, and climate adaptation projects.
Ultimately, sustainable finance serves not only a protective function but also a strategic one, enabling the mobilization of capital toward emerging sectors critical for Georgia’s long-term resilience. Investments in renewable energy, energy efficiency, climate-resilient agriculture, sustainable infrastructure, nature-based solutions, and SME development create new economic opportunities while strengthening adaptive capacity. Sustainable finance is becoming a central pillar of financial sector policy, risk management, and economic development, positioning Georgia to build a more resilient and competitive economy in an era of global sustainability transition.
Conclusion
The era of climate change demands a fundamental transformation of the global financial system. Sustainable finance provides the strategic framework to navigate this transformation by aligning financial stability with environmental and social well-being. It equips financial institutions with the tools to understand and manage climate risks, while simultaneously mobilizing capital towards sustainable and resilient economic development.
Georgia’s proactive approach—through regulatory reforms, climate stress testing, ESG guidelines, taxonomy development, and international cooperation—demonstrates that small and emerging economies can become leaders in sustainable finance innovation.
The ultimate objective is clear: build a financial system that is resilient, responsible, and aligned with a sustainable future. In doing so, countries strengthen not only their financial stability but also their long-term prosperity and societal resilience in an increasingly uncertain world.
Giorgi Mukhigulishvili is an energy and climate policy specialist whose work advances the integration of climate risk management and sustainable finance frameworks within financial institutions. His expertise in GHG accounting, climate risk assessment, and EU-aligned sustainable finance taxonomies positions him to connect climate science with financial sector resilience.
references:
Breaking the tragedy of the horizon – climate change and financial stability – speech by Mark Carney, 29 September 2015.
The impact of climate change on the UK insurance sector
Implementing the Recommendations of the Task Force on Climate-related Financial Disclosures, TCFD, October 2021
Recommendations | Task Force on Climate-Related Financial Disclosures
A framework for the voluntary disclosure of climate-related financial risks
Sustainable Finance, National Bank of Georgia
Sustainable Finance Roadmap
Climate Stress Test, NBG
Sustainable Finance Taxonomy, NBG
