PHYSICAL RISKS IMPACT MEASUREMENT

Physical risk integration requires more than hazard mapping, it demands a structured translation of climate data into financial risk metrics. Finalyse has developed a robust framework to translate climate hazard intensities into financial shocks. Our methodology follows a structured path:

1. Portfolio & Hazard Scoping: We identify material hazards (e.g. river floods, droughts) across relevant geographies and determine exposure concentration at counterparty and collateral level.
2. Data Collection & Geospatial Mapping: We map physical assets, collateral locations and sector exposures against forward-looking climate projections and return-period evolution. 
3. Impact Function Calibration: Sector and asset specific damage functions are sourced from academic literature and supervisory publications, then calibrated to reflect portfolio characteristics.
4. Financial Transmission Channels: We quantify, direct damages to physical assets, Collateral value reductions, Revenue and production shocks (e.g. agriculture, hydropower) and Business interruption effects. These impacts are then translated into financial statement stress.
5. Credit Risk Parameter Adjustment: We integrate physical risk into credit models using: 
   • Collateral haircuts and LTV shocks
   • LGD adjustments based on expected damage
   • PD scaling factors driven by changing hazard probabilities
   • Structural modelling approaches (Merton/Vasicek with jumps)
   • Simulation based methodologies for tail risk estimation
6. Portfolio & Capital Impact Assessment: We assess:
   • RWA impacts
   • Expected loss and capital impact
   • Scenario comparisons (baseline vs climate-adjusted)
7. Governance & Model Risk Considerations: Given reliance on forward-looking projections and impact functions, we ensure transparent documentation, sensitivity analysis and model risk governance.