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With efforts to combat global warming likely stalled amid a shift in U.S. policy and eroding global cooperation, banks are likely facing modest transition risk from climate policy, but elevated long-term physical risk, says Morningstar DBRS Inc.

In a new report, the rating agency said that recent developments at the Net Zero Banking Alliance (NZBA) — which has seen several large U.S. and Canadian banks withdraw from the group, and a potential change in its commitment to limit warming (from the initial pledge of 1.5 Celsius to “well below” 2 C) — aren’t material for the sector’s current credit ratings.

Easing the group’s commitment to limit warming, “would be a pragmatic move, given the slow pace of transition we have seen, but it would also remain an ambitious target because it would still mean that we are on path for an orderly transition towards net zero, which implies lower transition costs compared to an abrupt or disorderly transition,” the report said.

Indeed, even the weaker commitment would still be aligned with the requirements of the Paris Agreement treaty, it noted.

However, as it stands, the world is on track to fall well short of the Paris Agreement pledges.

“… It is likely that we are in a scenario of climate policies that have already been implemented but not much more than that,” the report said. “This means we are heading towards a 2.5-3.5-degree Celsius warming, which is well above” the goal of limiting global average temperature rise to well below 2 C.

In this scenario, while transition risk is limited, the physical risks posed by climate change — from damaging events such as extreme weather, floods, heatwaves, and wildfires that cause financial losses — will remain elevated.

“The actual timing of physical risk is not known but a recent analysis indicated that, globally, physical risks are rising faster than previously expected,” the report said.

In turn, rising physical risk has potential financial implications, including reduced insurance coverage, which spells higher housing costs, and ultimately increased credit costs for banks.

Yet, altering the NZBA pledge, “has no consequence on physical risk in the next decade,” the report said.