But smaller economies with more limited capacity to respond to disasters and climate threats will wear the greatest effects, the IMF study finds.

The IMF has measured the impact of climate disasters on stock market indexes in a new study, Equity Investors Must Pay More Attention to Climate Change Physical Risk. The IMF has examined around 350 large climatic disasters over the past 50 years in a sample of 68 economies, representing 95 per cent of global GDP.

The average effect on stocks was modest: a drop of 1 per cent for market indexes overall and 2 per cent for banking stocks.

However, in 10 per cent of cases, the impact on the aggregate market has been greater than 14 per cent, “indicating that some climatic disasters can have a meaningful effect on financial stability,” the study authors Felix Suntheim and Jérôme Vandenbussche found.

Nathan Zaia, banking analyst for Morningstar, says that If a severe weather event causes a large economic shock, Australian banks would be unable to escape given they lend to almost every industry and to individuals.

“It is hard to say what risks are priced into a share price, but we do not think climate risk is top of investors mind when it comes to banks,” Zaia says.

Given the highly leveraged businesses of banks, which are inextricably tied to the strength of the economy, they’re always vulnerable to economic downturns ¬– whether they’re caused by climate, health crises or other factors.

But as in the current example of COVID-19, government stimulus can buffer the impact on banks.

“With Australian banks heavily exposed to mortgages, the flow on impact to unemployment and the ability of borrowers to service loans would be key.

“It’s also important to take into consideration the impact on share prices, versus the impact on underlying earnings, which may not be as severe,” says Zaia.

Big impacts possible
The IMF study found that the 2011 Thai floods had the largest damage relative to the economy's size, amounting to around 10 per cent of Thailand's GDP. The floods triggered a 30 per cent drop in the stock market over 40 days.

In the US, Hurricane Katrina had the largest damage in absolute terms at 1 per cent of US GDP, yet it had “no discernible impact” on the US stock market.

The study finds that countries with more “fiscal space” such as the US and Australia, can more swiftly respond to the disaster in the form of financial relief and reconstruction efforts.

“Also, well-developed risk-sharing mechanisms such as insurance reduce or redistribute the disasters’ losses and limit the impact on equity prices,” Suntheim and Vandenbussche found.

The IMF researchers found that over the past decade, direct damages of climate disasters are estimated to add up to around US$ 1.3 trillion (or around 0.2 per cent of world GDP) on average, per year.

Some investors ignore risks
Looking back at 2019 equity valuations across countries, many equity investors did not account for commonly discussed global warming scenarios physical risks in their investments. "This apparent lack of attention could be a significant source of market risk looking forward," Suntheim and Vandenbussche found.

According to Morningstar’s ESG specialist research firm, Sustainalytics, some investors are avoiding climate disasters by not investing in companies involved with fossil fuels such as coal, which contribute to global warming.

Yet for every investor that backs away from fossil fuels, there may be another willing to do business with or invest in that company.

“The important commitments and steps by investors and miners to walk away from coal are necessary, but divestment alone may take too long to make a meaningful difference.

“Additionally, cutting a financial relationship means losing leverage to influence change, engage with management, and vote,” say Enrico Colombo, Sustainalytics’ manager Asia Pacific research and Frances Fairhead, senior associate mining research.

They suggest a better way must be found to deal with coal, pointing to the example of Australian mining company Genex Power.

Genex converted an abandoned gold mine in Australia into a pumped hydro project, giving a second life to a mothballed asset and maintaining economic activity around it. Similar projects are in early stages in the US to turn old coal mines into solar farms.

According to Sustainalytics, sustainable investing is growing rapidly with more than US$85 trillion ($122 trillion) in assets under management from signatories to the Principles for Responsible Investing.

The growing number of sustainable assets means investors are becoming more sophisticated in their use of information and data on environmental, social, and governance factors within their investment portfolios.

Climate change stress testing can also provide financial organisations such as banks with a better understanding of the size of their exposures and the associated physical risk, say the IMF’s Suntheim and Vandenbussche.