How does physical risk affect the profitability of financial companies?

This study investigates the impact of physical risk management on the profitability of financial firms across over 60 countries from 2020 to 2023, utilizing Moody's ESGPhysical Risk Management Score. Analysing a sample of 961 financial institutions, the research reveals a counterintuitive finding: firms with higher physical risk scores, indicative of poorer management of physical risks, are associated with better returns on assets (ROA). This suggests that despite inadequate risk management practices, these firms may leverage financial strategies to offset potential losses. While the effect of physical risk on return on equity (ROE) is less pronounced, larger firm size and higher liquidity emerge as significant positive determinants of equity returns. Non-performing loans (NPL) consistently exhibit a negative relationship with both ROA and ROE, underscoring the critical role of credit risk management. These findings highlight the need for financial firms to prioritize effective physical risk mitigation strategies to enhance profitability and ensure long-term sustainability, despite the observed complexities in the relationship between risk management and financial performance.