From Hazards to Balance Sheets: A Practical Guide for Banks to Assess and Model Physical Risk (European Banking Federation)

Summary

• Natural disasters caused an estimated US$224 billion in economic losses and US$108 billion in insured losses during 2025 alone.p.9
• The C-ESG Risk Roundtable was set up in late 2022 under the European Banking Federation with the participation of 14 European banks, with the EBF and the ECB as observers.p.5
• This is the second report of the Physical Risk Workstream, building on a first report published in September 2024.p.9
• The report develops a practical framework that sets a common language for physical risk assessment and traces transmission from hazard to banking outcome.p.6
• Physical risk can reach a bank through three broad transmission-channel families: collateral devaluation, deterioration of client financial strength and devaluation of assets held by the bank.p.20
• Physical hazards affect company financial outcomes through three pathways: asset and operational, market, and macro-economic.p.23

Key insights

1. A physical risk assessment aims to translate hazard exposure into impacts on assets and operations, then into financial impacts and finally banking outcomes.p.10
2. Damage to buildings is only one route to financial loss, since a company with an undamaged factory may still be unable to produce because a supplier, transport corridor, electricity network, labour pool or water resource is disrupted.p.7
3. Physical risk assessments should be read as decision-support tools rather than precise forecasts, because model outputs are conditional estimates made under uncertainty.p.12
4. For lending exposures, physical risk can weaken borrower creditworthiness and probability of default (PD), and reduce collateral value and thereby affect loss given default (LGD).p.21
5. The paper starts from the EU Taxonomy hazard classification but does not keep its acute versus chronic distinction for modelling purposes.p.14
6. Underlying entity types (real estate, corporates, government entities and financial institutions) link banking products to the relevant physical transmission pathways.p.18
7. A scope convention (A, B and C) describes where impacts originate, but does not replace the transmission-pathway framework.p.24
8. Adaptation, resilience and risk-transfer measures can act at different stages: hazard reduction, exposure reduction, impact reduction, and dependency and continuity management.p.26