Is Climate Risk Increasing the Cost of Capital?

In the finance and insurance sectors, risk is not an element to be avoided but a component to be priced.

For banks, brokers and investors charging a premium to clients exposed to risks is fundamental to their business model.

Climate change presents a risk that is becoming increasingly widespread.

For many years, the insurance industry has adjusted to extreme weather events. In the United States, for instance, states around the Gulf of Mexico that are prone to hurricanes typically have higher insurance premiums. As the effects of climate change intensify, these premiums are rising.

This trend is not limited to insurance policies. New analysis from Bloomberg indicates that companies facing major climate threats are already paying a measurable premium on their cost of capital.

The research shows that firms with 10 percentage points higher asset damage rates from climate hazards face an additional 22 basis points in their average cost of capital.

This premium remains even after accounting for sector, region and company size.

This suggests that markets are systematically penalising businesses exposed to climate risk. "In other words: if you’re more exposed to storms, floods, or heatwaves, financing gets more expensive – and valuations take a hit," explains Niall Smith, a researcher at Bloomberg who led the study.

Quantifying the cost of climate threats

The Bloomberg findings are one of the first comprehensive attempts to measure whether physical climate risk, as opposed to transition risk, carries a detectable financing cost across global equity markets. The analysis examined publicly listed companies worldwide.

It linked their physical climate exposure to financing costs through regression analysis utilising physical risk indicators that assess potential assetdamage from 10 climate hazards, including cyclones, flooding and heat stress.

Initially, the climate risk signal was not obvious in the raw data. The relationship only became clear through the regression analysis that controlled for structural factors, with the 22 basis point effect proving to be robust.

Industrial and regional disparities in risk pricing

The financing penalty for climate risk shows considerable variation by sector. Asset-intensive industries appear to bear the highest costs, with materials companies facing a 56 basis point premium and utilities paying 45 basis points more.

The analysis notes this is "theoretically consistent", as markets are attuned to the fact that asset-intensive sectors are more exposed to the physical impacts of climate change.

Other sectors showed coefficients below the global average.

Disparities are also pronounced geographically. The Bloomberg analysis shows that Latin American companies face a 94 basis point premium for equivalent climate exposure, more than 4 times the global average. Asian firms face 25 basis points in additional costs.

In contrast, the effect in developed markets seems to be weaker. The analysis controlled for sectoral composition, suggesting these regional differences may reflect geographical risk pricing rather than industrial mix.

The role of disclosure in managing financing costs

These findings have major implications for investors and corporate strategy. For companies, the research suggests that implementing climate adaptation strategies could yield financial benefits beyond just operational resilience.

Bloomberg recommends that investors should "fully integrate physical risk factors into valuations, discounted cash flow models, asset allocations and wider investment processes to maintain risk-adjusted returns."

The analysis concludes that corporates could potentially lower their financing costs. By demonstrating resilience to physical risk through disclosure of climate risk assessments and clear adaptation plans, they may lower their financing costs moving forward.