By Hassan Salahuddin

Climate-related risks were formally incorporated into Pakistan’s financial sector regulatory framework in 2025, reflecting growing recognition of environmental challenges as a key source of financial vulnerability, according to the Financial Stability Review 2025 released by the State Bank of Pakistan (SBP).

The report indicates that the central bank introduced a comprehensive framework for the effective management of climate-related financial risks, requiring banks, development finance institutions, and microfinance banks to integrate climate considerations into their governance, strategy, and risk management practices. This marked a significant shift toward aligning financial sector policies with emerging global standards on climate risk management.

In addition, the SBP issued detailed guidelines on climate stress testing, enabling financial institutions to assess the potential impact of climate-related risks on their portfolios. These risks include both physical risks, such as floods and extreme weather events, and transition risks arising from changes in policies, technologies, and market dynamics associated with the global shift toward a low-carbon economy.

The report highlights that Pakistan’s exposure to climate-related risks has increased in recent years due to the rising frequency and intensity of natural disasters. Events such as floods and extreme weather have had significant economic and financial impacts, underscoring the need for a proactive approach to risk management within the financial system.

To support climate resilience, the government, in collaboration with the SBP, also launched a Climate Risk Fund under the Resilient and Accessible Microfinance initiative. The fund is aimed at providing liquidity support to small farmers affected by climate shocks and promoting climate-resilient agricultural practices.

The SBP also advised financial institutions to use Pakistan’s Green Taxonomy as a reference framework for developing and updating their green banking policies. This initiative is intended to guide investment toward environmentally sustainable activities and support the transition to a greener economy.

The report notes that integrating climate risk into financial regulation is essential for safeguarding financial stability in the long term. By identifying and managing climate-related exposures, financial institutions can reduce vulnerabilities and enhance their resilience to environmental shocks.

At the same time, the incorporation of climate considerations into financial decision-making is expected to encourage sustainable investment and improve resource allocation across the economy. This approach aligns with global trends, where central banks and regulators are increasingly prioritizing climate risk as part of their financial stability mandates.

Despite notable advances, the report emphasizes the need to strengthen data availability, upgrade risk-assessment frameworks, and deepen institutional capacity to effectively manage climate risks. Continued collaboration among regulators, financial institutions, and other stakeholders will be critical for advancing this agenda.

The inclusion of climate risk in the regulatory framework reflects a broader shift toward building a more resilient and sustainable financial system capable of addressing emerging environmental challenges.

Credit: INP-WealthPk