Integrating Climate Risks into Financial Regulation: Basel III in the Context of ESG and Stranded Assets

Abstract

This article provides a finance-centered review of how climate-related physical and transition risk drivers affect financial stability and interact with the Basel III regulatory framework. It distinguishes climate-related financial risk from the broader environmental, social, and governance (ESG) framework and argues that aggregate ESG measures should not be treated as direct substitutes for prudential risk indicators. Instead, climate-related risk drivers may materialize through established financial risk categories, including credit, market, liquidity, and operational risk. The study contextualizes stranded assets and assets-at-risk as transmission channels through which transition pressures may affect asset valuation, borrower creditworthiness, credit allocation, and bank resilience. Drawing on academic research and regulatory guidance, the article evaluates the roles and limitations of capital requirements, supervisory review, scenario analysis, stress testing, and climate-related disclosure in identifying and managing such vulnerabilities. The analysis suggests that climate-related financial risks should be incorporated into prudential decision-making on the basis of financial materiality and identifiable risk transmission channels rather than through the mechanical use of aggregate ESG scores or broad green-brown classifications. Climate-related and broader sustainability disclosures can support this process by improving the information available for risk identification, supervisory assessment, and market discipline. The article contributes to the literature by clarifying the conceptual boundary between ESG frameworks and climate-related financial risk and by linking climate-risk drivers, prudential mechanisms, disclosure practices, and stranded-asset implications within a common regulatory perspective.