Why banks in Bangladesh should embed climate risk across their operations

Bangladesh's banking industry stands on the frontline of climate change. The recent circular on Sustainability and Climate-Related Financial Disclosure Guidelines by the Bangladesh Bank (BB), in line with International Financial Reporting Standards (IFRS) S1 and S2, signals a new era in financial supervision. The country is one of the most vulnerable ones to climate change due to extreme weather events and erratic rainfall. Climate change-induced frequent floods, cyclones, droughts, and salinity intrusion are disrupting livelihoods, demolishing assets, and weakening borrowers' ability to repay. Unless the banking sector responds proactively, climate risks will harm the financial system as a whole. Climate change can no longer be overlooked as merely an environmental issue; it is now a firm concern for financial stability.

Climate risks affect banks in two interconnected ways. The first is through physical risks, which arise from direct impacts of climate events on borrowers, collateral, and operations. A cyclone that washes away shrimp farms in Khulna, for example, not only wipes out the borrowers' income but also devalues the mortgaged land, creating a double exposure to trouble for lenders. These are not theoretical risks; they are present realities.

The second pathway is through transition risks, which arise as the world moves towards decarbonisation. Stricter environmental, social, and governance (ESG) regulations, the phasing out of coal and high-emission industries, and changing consumer preferences can all impact the profitability of businesses that banks currently finance. While transition risks can be transformed into opportunities for green lending, the physical risks almost always lead to higher default rates and asset impairment.

International evidence supports this reality. Research shows that climate shocks increase non-performing loans (NPLs) and reduce credit supply. Banks exposed to high-carbon sectors also face reputational risks, regulatory penalties, and stranded assets as policies tighten. In Bangladesh, where a significant portion of formal lending is concentrated in climate-exposed sectors—agriculture, cottage, micro, small, and medium enterprises (CMSMEs), and power—the climate-related risks are higher. Without integrating climate risks into credit appraisal and portfolio management, banks will struggle to sustain asset quality and long-term profitability.

This is where the new disclosure guidelines come into play. By requiring banks to assess and publish information on climate-related risks, BB has taken an important step towards aligning the financial sector with global frameworks, such as the Task Force on Climate-related Financial Disclosures (TCFD) and the International Sustainability Standards Board (ISSB) standards. But disclosure is only the beginning. Banks must not treat it as a box-ticking exercise. Instead, they need to embed climate risk management into their core operations, governance, and strategy.

The first priority is stress testing. Banks must develop models to simulate how different climate scenarios, such as a major cyclone hitting coastal Bangladesh or a sudden increase in carbon tax on export industries, would affect their loan books. These exercises will indicate sectoral vulnerabilities and guide adjustments in lending strategies. For example, excessive exposure to high-risk coastal agriculture without adequate insurance or resilience measures could be flagged and reduced.

Second, banks need to integrate climate considerations into credit decisions. This means going beyond traditional financial ratios, and examining whether clients are vulnerable to flooding, whether they use energy-intensive technologies, or whether they have transition plans. Carbon-intensive projects should carry higher risk premiums, while low-carbon and climate-resilient investments should be incentivised. Already, some global banks are linking loan pricing to borrowers' emission reduction targets, thus, Bangladeshi banks cannot remain far behind.

Third, the industry must significantly expand its green and sustainable finance portfolio. In 2024, banks disbursed around Tk 30,653.78 crore as green finance, up from Tk 19,304.31 crore in 2023. While this growth is encouraging, much of it still appears to be compliance-driven rather than driven by the strategic vision of the banks. Banks need to innovate by issuing green bonds, developing sustainability-linked loans, and mobilising concessional finance in partnership with development agencies. Climate-resilient agriculture, renewable energy, energy-efficient machinery, and waste-to-resource projects—all represent opportunities for profitable and impactful lending. Transitioning into these areas is not just good for society; it is good business.

Fourth, banks must strengthen disclosure and transparency. Under the new guideline, publishing climate risk exposure and climate-related financial disclosure will be mandatory by 2027. 

 the credibility of these disclosures will depend on data quality and methodology. Boards and senior management must take ownership of climate reporting, rather than relegating it to related departments. Transparent disclosure will not only meet regulatory requirements but also enhance investor confidence, especially as global financiers increasingly demand climate accountability.

Of course, the central bank itself has a critical role. BB has long been recognised as a pioneer in green banking, not only in South Asia but also globally. Yet, the challenge now is enforcement and capacity building. Guidelines alone will not deliver change unless backed by strict monitoring. The central bank should make climate stress testing mandatory for all scheduled banks, supported by globally accepted standardised scenarios and methodologies.

Equally important, the central bank must provide incentives. Low-cost refinance schemes, such as the Green Transformation Fund (GTF), Technology Development Fund (TDF) for green projects, and recognition in sustainability ratings can all encourage banks to scale up their efforts. Just as importantly, BB should promote capacity building—training bank staff, developing tools, and fostering partnerships with international climate finance institutions. Without these enablers, disclosure may remain a compliance burden rather than a catalyst for genuine transformation.

Ultimately, the stakes are clear. If banks ignore climate risks, they risk rising defaults, stranded assets, and declining profitability. But if they embrace climate resilience, they can unlock new growth opportunities and support Bangladesh's national development goals. Financing climate-resilient infrastructure, renewable energy, and adaptation projects will not only safeguard bank balance sheets but also protect millions of people living on the frontlines of climate change.

The time for incremental change is over. Bangladesh's financial industry must now decide whether it will be a passive victim of climate risks or a proactive agent of climate resilience. The central bank has set the direction; it is up to the industry to follow through with conviction.

Cover photo:  Banks exposed to high-carbon sectors face reputational risks, regulatory penalties, and stranded assets as policies tighten. PHOTO: FREEPIK