In recent years, financial regulators globally, including the Central Bank of Kenya (CBK), have heightened their focus on climate risk disclosures in the banking sector. This increased scrutiny is not isolated, as the financial industry plays a critical role in driving sustainable practices and mitigating the risks posed by climate change.

The Draft Climate Risk Disclosure Framework for the Banking Sector, released for public input earlier this week by the CBK, is part of this broader global movement toward embedding sustainability within financial regulation. By ensuring that banks collect and disclose climate-related information consistently, regulators aim to foster greater transparency, accountability, and alignment with the urgently needed low-carbon transition.

Why regulators are focusing on climate disclosures

Regulators are increasingly keen on climate disclosures because the risks related to climate change—physical, transitional, and liability—can have far-reaching implications for financial stability. Climate change poses a systemic risk, with the potential to destabilise the financial system through direct impacts on assets (physical risks like floods and droughts) and through the transition to a low-carbon economy (transitional risks, such as policy changes, technology shifts, and market changes). Banks, being the lifeblood of the economy, are exposed to these risks through their lending and investment portfolios. By mandating climate disclosures, regulators can ensure that these risks are systematically assessed and managed within the financial sector.

Moreover, stakeholders, including investors and shareholders, are increasingly demanding transparency on how financial institutions address climate risks. The disclosure framework is designed to provide them with the necessary information to assess the financial impacts of climate-related risks, enhancing decision-making and directing investments toward sustainable initiatives. Ultimately, better climate disclosures help investors differentiate between institutions that are prepared for the low-carbon transition and those that are not, promoting market discipline.

Impact on banks and their operations

For banks, the rising focus on climate disclosures means a fundamental shift in how they operate and manage risks. Compliance with the Climate Risk Disclosure Framework will require banks to integrate climate-related risks into their governance, strategy, risk management, and reporting processes. This integration extends beyond mere reporting—it demands that banks take a proactive role in identifying, assessing, and mitigating climate risks across their portfolios.

Banks must now evaluate not only the financial performance of their borrowers and investments but also their environmental impact. Industries with high carbon footprints or those vulnerable to extreme weather events may represent greater risks, requiring banks to re-evaluate their risk appetite, loan pricing, and capital allocation strategies. For instance, lending to a company heavily reliant on fossil fuels or other carbon-intensive industries might expose the bank to transition risks as economies shift toward cleaner energy sources. As such, banks will have to carefully assess which sectors and projects align with long-term sustainability goals.

Potential challenges for banks in meeting disclosure requirements

While the draft framework aims to increase transparency, compliance may not be without challenges. One key hurdle for banks is the lack of standardisation and comparable climate data, which can complicate the process of quantifying and reporting climate-related risks. In Kenya, where environmental data infrastructure is still evolving, banks may find it difficult to gather precise and reliable data to fulfil the disclosure requirements. Furthermore, many banks, particularly smaller institutions, may lack the internal capacity or expertise to fully understand and model the long-term impacts of climate change on their portfolios.

The evolving nature of regulatory expectations would also pose challenges. As climate science and policies evolve, so too will the metrics and frameworks that banks need to adhere to. This creates a moving target for financial institutions, requiring ongoing adjustments to their risk models, reporting systems, and governance structures. Banks will need to invest in climate risk assessment tools, data analytics, and staff training to meet these dynamic demands.

Opportunities for banks in the low-carbon transition

Despite these challenges, the push for greater climate disclosure presents significant opportunities for banks. By aligning themselves with sustainable financing, banks can position themselves as leaders in the low-carbon transition. Many sectors are increasingly seeking green financing, and banks that offer innovative products, such as green bonds, sustainability-linked loans, or carbon-offset financing, can tap into new revenue streams. This shift is supported by growing investor interest in environmental, social, and governance (ESG) criteria, which reward banks that align their portfolios with sustainable development goals.

Furthermore, by improving transparency and aligning with global climate disclosure standards, banks can enhance their reputation and build trust among investors, clients, and the broader public. This can lead to increased capital inflows from institutional investors focused on sustainability. Banks that lead in climate risk disclosures may also gain a competitive advantage, as they demonstrate resilience to long-term climate risks and show foresight in addressing future regulatory requirements.

Potential steps towards compliance

To effectively meet the requirements of the Climate Risk Disclosure Framework, banks should first assess their current level of climate risk exposure and reporting capabilities. Conducting climate risk assessments across their portfolios will provide a baseline understanding of the risks involved and highlight areas where they need to improve their disclosure practices. Banks can collaborate with external consultants, environmental experts, or data providers to develop or refine their climate risk assessment models.

Banks should also prioritise building internal capacity and establishing clear governance structures for climate-related issues. Integrating climate risk considerations into board-level discussions and decision-making processes will ensure that these risks are appropriately managed. In addition, they must train staff at all levels to understand the implications of climate risks and align their business strategies accordingly.

Finally, collaboration with stakeholders is key. Banks can engage with regulators, investors, civil society organisations, and clients to ensure that they are not only compliant but also actively contributing to a sustainable financial ecosystem. By doing so, banks can transform climate risk disclosures from a regulatory obligation into a strategic opportunity for growth and leadership in the financial sector.

The increasing regulatory focus on climate disclosures is transforming the way banks operate, with significant implications for risk management, governance, and investment strategies. While compliance with frameworks like the CBK’s draft Climate Risk Disclosure Framework may pose challenges, it also opens new opportunities for banks to lead the transition toward a low-carbon economy. By embracing these changes and embedding climate considerations into their core operations, they can contribute to a more sustainable future while securing their long-term resilience and competitiveness in a rapidly evolving financial landscape.