BOJ and JFSA Conduct Pilot on Climate Risk Stress Tests

BOJ and JFSA adopted a bottom-up approach, whereby BOJ and JFSA laid out a basic framework with the three NGFS scenarios (net zero 2050, delayed transition, and current policies) and let financial institutions conduct the analysis with their own models in line with the framework. The results indicated that the banks’ estimated increase in annual credit costs due to transition and physical risks was considerably lower than their average annual net income. The levels of the estimated increase in credit costs were not significantly different from those published by individual banks in their Task Force on Climate-related Financial Disclosures (TCFD) reports, although caution is warranted in the comparison due to the differences in models and sectors covered. The results also demonstrated that each bank had the capacity to conduct a risk analysis not only for the scenarios set in its own TCFD report but also for the common scenarios of the exercise (NGFS scenarios).

The pilot exercise also revealed that the estimated results significantly depend not only on banks’ analytical models and the selection of variables for the models, but also on additional assumptions made by each bank. With a lack of information and data on future prospects, the assumptions varied in how businesses and technologies in the specific sectors will evolve, whether and how clients' business models will be transformed, to what extent clients will be required to finance in transforming their business, and to what extent increased carbon prices will be passed on to the selling prices. The application of a scenario analysis in engagement with clients to support addressing climate change would require banks to refine their analysis of individual companies. As a refinement, banks may need to consider the impacts of structural changes in related industries on individual companies as well as the effects of business transformation by individual companies with banks’ engagement.

To utilize such scenario analysis in the business strategy development and risk management, financial institutions need to further enhance the methodology, including addressing the issues identified in the exercise, taking into account their risk profiles as well as international discussions and developments in practice. Going forward, BOJ and JFSA will continue dialog with financial institutions on methods and practical application of the scenario analysis, including on how to address the issues identified in the exercise. BOJ and JFSA will also contribute to the improvement of standard scenarios and international data initiatives, including through sharing the issues identified in this exercise with central banks and supervisory authorities at international forums.

Keywords: Asia Pacific, Japan, Banking, Climate Change Risk, ESG, NGFS Scenarios, TCFD, Scenario Analysis, Stress Testing, NGFS, BOJ, JFSA