Physical risks and the role of insurance in risk mitigation

Contribution by Patrick Montagner, Member of the Supervisory Board of the ECB, for Eurofi Magazine

Frankfurt, 24 March 2026

Climate risk remains material for banks

The financial impact of climate-related risks on the banking sector continues to grow,^[1] even as political attention in some jurisdictions wanes. Insurance can mitigate losses, but banks still need to understand and manage physical risk exposures.

Under the prudential framework, the ECB set out clear supervisory expectations in 2020 on managing physical climate risks. The European Banking Authority Guidelines on managing environmental, social and governance risks require institutions to integrate climate and environmental risks – including physical risks – into their governance, strategy and risk management processes.

Physical risks: evidence and gaps

Supervisory work shows that physical risks are significant, and risk management still needs to improve. Our 2022 thematic review on climate-related and environmental risks found that banks’ approaches to managing physical risks were generally less advanced than those for managing transition risks. Shortcomings were identified in the granular identification of exposures, the use of forward-looking assessments of physical hazards and the integration of physical risks into credit decisions and pricing.

The ECB’s 2022 climate risk stress test showed that physical risks were already relevant for many banks. Across the scenarios tested, certain portfolios had non-negligible losses. These findings were consistent with broader economy-wide stress tests, indicating that the physical risks associated with delayed action are likely to be costlier than an orderly transition to a low-carbon economy.^[2]

Since 2023, Pillar 3 disclosure requirements have increased transparency around banks’ exposures to physical risks. A significant share of exposures is reported to be subject to physical risks, while banks’ capabilities to estimate related losses remain limited.^[3]

This assessment is reinforced by banks’ own capital adequacy assessments: around 90% of banks consider themselves to be materially exposed to physical risks. Senior leaders at major financial institutions have also acknowledged the costs of climate change are rising and are already affecting business models.^[4]

Insurance mitigates physical risks but poses structural challenges

Insurance remains an important means of mitigating physical risks, particularly where real estate collateral is concerned. However, supervisory findings show that reliance on insurance alone is insufficient. According to the European Insurance and Occupational Pensions Authority (EIOPA),^[5] only around a quarter of climate-related losses in the EU are insured, with substantial variation across countries. Beyond direct property damage, business interruption-related losses can be substantial following climate events, yet coverage for such losses also varies widely. Insufficient or uncertain insurance coverage increases exposure to losses and complicates assumptions about collateral protection over the loan life cycle.

Supervisory discussions with banks, EIOPA and national authorities have identified several structural challenges that limit banks’ ability to monitor insurance coverage over time. Insurance contracts are typically renewed annually in many countries, while loans often extend over several years, and sometimes decades. Therefore, coverage in place at loan origination does not guarantee continued protection, and banks may have limited visibility of renewals or changing policy terms.

Banks have also benefited from government support following major natural disasters. However, as climate impacts intensify and the associated fiscal costs increase, reliance on public intervention may become less viable.

Banks are stepping up their physical risk management practices

In response to these challenges, banks are increasingly complementing insurance-based mitigation with broader physical risk management practices. Some institutions have developed centralised systems that combine geolocation data, risk assessments, collateral information and insurance coverage. Others are enhancing monitoring processes and borrower engagement to improve data availability over time.

Risk assessment frameworks are also evolving. In addition to loan-to-value ratios, banks are increasingly incorporating location-specific physical risk indicators as well as information on insurance availability and on the presence of mitigation measures, such as flood protection. These developments support a more comprehensive assessment of vulnerabilities and help address some of the limitations associated with insurance coverage.

Nevertheless, experts warn that current models may underestimate physical risks, particularly as they do not account for tipping points or compounding events, while climate impacts are materialising faster than previously assumed. ECB Banking Supervision will continue to analyse these challenges under its priorities for 2026-28, including further work on physical climate risks.