( ii ) the sizeable exposures of the financial sector to this form of risk ; and ( iii ) the presence of externalities. the financial sector is exposed to these physical risks through several channels. physical risks are of course relevant for the valuation of real estate assets, the main collateral of bank loans. physical risks also matter when assessing the ability to pay of borrowers involved in p. bolton, m. kacperczyk, h. hong and x. vives ( forthcoming ), “ resilience of the financial system to natural disasters ”, iese business school and cepr. see the financial stability board ( november 2020 ) : the implications of climate change for financial stability. sectors that could be particularly affected, such as agriculture or tourism. capital destruction could also be very important. furthermore, since not all geographies would be equally affected, the migration of activities and of the population in some areas will increase, generating an impact on the financial sector as well. precisely to prevent these risks increasing further, acting to prevent the materialisation of climate change is essential. however, such interventions, and the accompanying changes in consumer and investor sentiment in favour of a greener economy, may also create their own particular risks to the financial sector. indeed, the transition towards an environmentally sustainable economy implies a sweeping change in production technologies and a reallocation of activity across sectors and companies. actually, such restructuring will mean that, in the short run, some sectors will increase their profits while others will incur losses, with obvious implications for the financial system and its stability. in this case, for estimating transition risks, the most relevant factors are the carbon footprint and the environmental impact of the sectors and companies to which financial firms are exposed. in this context, and as part of our main responsibility to guarantee the stability of the financial system, we - regulatory and supervisory authorities - must ensure that the materialisation of climate risks does not endanger financial stability. therefore, we must make sure that financial firms address these risks. in particular, we should contribute to identifying climate - risk drivers and their transmission channels, to the adequate measurement of the economic and financial impact of the different risks, and to the definition and development of the potential mitigation and riskreduction measures. if we succeed in incorporating these risks into the decisions of the financial sector, this will translate into a change in the relative prices of financial instruments. and, in turn, that will help to internalise those

investors failed to do their own due diligence and instead relied too much on credit ratings as a measure of the overall risk in holding these complex debt instruments. among other things, they failed to take into account risks other than credit risks, in particular, market and liquidity risks. the complexity of these instruments frequently made them opaque, and too often investors put their money and confidence into vehicles that they did not fully understand. the basic loan quality of u. s. subprime mortgages worsened through 2005 and 2006, although this worsening did not become broadly apparent to the investors in securitized mortgages until the first half of 2007. 1 subprime loans were premised on continued increases in house prices. when house prices stopped rising, the belated realization by rating agencies of the poor quality of these loans resulted in the downgrading of structured products with exposure to subprime mortgages, often by several notches. these instruments were held by a variety of investment funds, including many sponsored by banks. indeed, the problem was exacerbated by the originate - to - distribute model, which led to misaligned incentives for the u. s. originators of subprime mortgages. some products were held directly by banks themselves. investors soon came to realize that highly rated structured - debt instruments could fall substantially in value and were subject to severe downgrades. as a result, they began to shun almost any type of structured product – either because the complexity of these products made it difficult for many market participants to understand them, and therefore to accurately price the attendant risk, or because they were really looking to hold only true aaa assets. in canada, these instruments included abcp. following the onset of the crisis, non - bank - sponsored abcp stopped rolling over in canada, which led to the standstill under the montreal accord. as time passed, the markets for securitized products became much less liquid to varying degrees across instruments. as market players observed the downgrades of structured products based on u. s. subprime mortgages and the drying up of abcp markets, two additional concerns emerged. first was a concern about the financial health of counterparties, particularly banks, as marked - tomarket losses eroded capital. second was a concern that securitization would proceed at a much slower pace than in the past, thus requiring reintermediation that would result in a more rapid expansion of bank balance sheets and an