When The Physics of Climate Meet Capital Markets

For much of the past decade, climate risk in finance has been framed primarily as transition risk. The debate has focused on regulation, policy ambition, timelines, and political alignment.  The result is often producing more heat than light.

What sits outside that debate is the underlying physics of climate change, and the increasingly observable way its physical impacts are now being reflected in financial markets. Across credit, insurance, and fixed-income markets, lenders and underwriters are doing what they have always done when faced with new sources of risk: measuring exposure, translating it into expected loss, and pricing it accordingly.

In this piece, we look at a growing body of central bank and peer-reviewed academic research that is now making this dynamic visible in hard numbers.

Physical Climate Risk Is Showing Up in the Cost of Capital

Evidence from bank lending markets across Europe and globally shows a consistent pattern: borrowers with greater exposure to physical climate risk face higher borrowing costs, stricter lending terms, or both.

Using a global dataset of nearly 86,000 syndicated bank loans, one study finds that firms operating in more climate-vulnerable countries pay higher interest rates on bank loans, with the effect particularly pronounced for long-maturity loans and financially weaker borrowers. Importantly, lenders are not responding only through price. The same research shows adjustments in non-price terms—such as collateral requirements and fees—indicating that physical climate risk is being integrated into broader credit risk management frameworks rather than treated as a narrative overlay.

More granular evidence reinforces this conclusion. Loan-level data from Ireland shows that firms located in flood-risk areas face interest-rate premia of roughly 7–13 basis points and are more likely to be required to post collateral. The study also finds that lenders partially price forward-looking flood risk linked to climate change, not just current hazard maps.  This suggests that expected future physical impacts are already influencing underwriting decisions.

There are clear physical implications here.  Physical climate risk is no longer theoretical or purely backward-looking. It is being incorporated into credit decisions today, especially where loan duration overlaps with hazard horizons.

Duration Matters: Long-Dated Exposure Is Penalized First

Across asset classes, the pricing of physical climate risk is consistently stronger for long-dated instruments.

In euro-area mortgage markets covering eight countries between 2010 and 2023, banks are found to demand a physical climate risk premium, with that premium increasing over time. Mortgages collateralized by properties in areas of average physical risk are estimated to be several basis points more expensive than those in no-risk areas, with significantly larger premia observed in more recent years.

Similar dynamics appear in U.S. mortgage markets. In zip codes where all properties are exposed to sea-level-rise risk, mortgage spreads are estimated to be roughly 7.5 basis points higher than in areas with no exposure, translating into nearly $9,000 in additional financing costs for the average borrower. Again, the premium is concentrated in longer-term mortgages, consistent with sea-level rise being a long-run physical risk rather than an immediate weather shock.

The same pattern holds in corporate credit. For U.S. bank loans, firms in the highest quartile of long-run climate exposure face materially higher loan spreads than those in the lowest quartile, with effects concentrated in long-term loans and among weaker borrowers.

Across markets, the time horizon of exposure matters because it determines whether financial exposures meaningfully overlap with—surprise—physical hazard horizons. Where it does, the pricing adjusts.

Municipal Bonds and Structural Signals

Physical climate risk is also being priced in public finance.

Counties with greater climate exposure pay higher underwriting fees and higher yields when issuing long-term municipal bonds, while no comparable effect is observed for short-term issuance.

More specifically, research on sea-level-rise exposure shows a statistically significant premium in municipal bond yields emerging by 2013, with larger effects for longer-maturity bonds and within-issuer comparisons strengthening the causal interpretation. The implied pricing suggests markets are incorporating expectations of reduced future cash flows or increased volatility tied to physical exposure.

These findings matter because municipal bonds are backed by tax bases, infrastructure, and local economic activity. When physical climate risk is priced here, it reflects a market-wide reassessment of long-term regional viability rather than isolated asset impairment.

Insurance Markets See It First, then Reprice Fastest

Insurance markets often provide the earliest and clearest signal of changing physical risk, because losses materialize directly on balance sheets.

In 2023 alone, global natural catastrophes caused economic losses of approximately USD 280 billion, with insured losses above long-term averages. Independent reporting from reinsurers shows a similar picture, with insured losses remaining elevated relative to historical norms and specific perils (such as severe convective storms) described as more destructive than ever.

More recent data indicates that more than half of global catastrophe losses remains uninsured, pointing to widening protection gaps and increasing residual risk borne by households, firms, and public balance sheets. Supervisory bodies, such as the European Insurance and Occupational Pensions Authority (EIOPA), emphasize improved risk assessment, prevention, and product design to address these gaps.

Abstraction to Pricing: Why Data Resolution Matters

What ties these findings together is not a shared climate narrative, but a shared reliance on data. Physical climate risk only becomes priceable when it is observable at the level of assets, locations, and cash flows.

High-resolution data on where companies operate, what assets they own, and how those assets intersect with physical hazards is now foundational to credit analysis, insurance underwriting, and investment decision-making. This applies across public and private markets, and across sectors. Naturally, the most sophisticated users of this data are often insurers and reinsurers, precisely because their business models demand disciplined quantification of downside risk.

Public datasets that track the frequency and scale of billion-dollar weather and climate disasters clearly anchor these assessments in observable loss experience. Overlaid with asset-level exposure data, it’s clear that markets are increasingly going to translate climate physics into expected financial outcomes.

The Bottom Line for Business and Finance

Physical climate risk has moved beyond being an abstract externality or a future-dated concern. It is being priced today (yes—unevenly, imperfectly, but increasingly consistently) across lending, insurance, and capital markets.

This shift does not require consensus on climate politics or policy. It reflects standard risk discipline responding to observable loss patterns and forward-looking exposure. Where risk can be measured, it can be priced. Where it yet cannot, it remains latent but not entirely absent.

Companies, investors, and lenders alike are gravitating to the simple understanding that physical exposure is not optional. It is becoming a prerequisite for credible risk management, capital allocation, and long-term resilience in a financial system that is decisively integrating the physics of climate into price.

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