HKMA Publishes Climate Risk Policy Manual and Stress Test Results

In light of the increasing threats of climate risks to the financial sector, HKMA had launched the pilot climate risk stress test in January 2021. Participating banks assessed their climate risk exposures under three scenarios: one physical risk scenario involving a worsening climate situation and two scenarios envisaging orderly and disorderly transitions to a low-emission economy. Twenty-seven banks, including 20 major retail banks and seven branches of international banking groups, participated in the exercise. The climate risk stress test results showed that the extreme climate scenarios assumed in the exercise would lead to a material reduction in the participating banks’ profitability due to an upsurge in expected credit losses from their exposures directly affected by climate change: for example, residential mortgages and lending to high-emitting industries. The results also revealed that climate change could also the capital positions of banks. The capital adequacy ratio of the domestic systemically important authorized institutions, for instance, would drop by three percentage points on average over the five-year horizon under the disorderly transition scenario. Some parts of the banks’ operations would be affected by the more intense climate hazards under the physical risk scenario. However, the assessment indicated that the banking sector remained resilient to climate-related shocks, given the strong capital buffers built up by the banks over the years.

In light of the climate risk stress test results, the participating banks have developed plans to strengthen their climate strategies and risk governance frameworks. Measures taken by the banks include the incorporation of a broader range of climate risk factors into the risk assessment frameworks and strategic allocation of additional resources to climate resilient activities, such as green financing and providing transition finance to support customer transition to low-emission business models. HKMA intends to undertake another climate risk stress test in two years.

Keywords: Asia Pacific, Hong Kong, Banking, Climate Change Risk, ESG, Stress Testing, Supervisory Policy Manual, Disclosures, Basel, SPM GS-1, Scenario Analysis, Lending, Credit Risk, HKMA