Featured Product

    IMF to Deepen Coverage of Climate Risks in Financial Sector Assessment

    February 05, 2020

    IMF published a paper that explains how its staff uses the results of stress tests for policy advice. The paper concludes by identifying the remaining challenges to make stress tests more useful for the monitoring of financial stability and offers an overview of the IMF staff work program in that direction. Going forward, the IMF staff plans to expand and deepen the coverage of climate-related risk in assessments under the Financial Sector Assessment Program or FSAP. Better understanding the macro-financial transmission of climate risks is where the IMF staff can build on their comparative advantages, help country authorities strengthen their policy frameworks, and contribute to the global debate.

    The paper explains the difference between a macro-prudential stress test and a supervisory stress test. After a brief section on the evolution of stress tests at IMF, the paper presents the key steps of an IMF staff stress test. This is followed by a discussion on how IMF staff uses stress tests results for policy advice. IMF stress tests primarily apply to depository intermediaries, and in particular, global and domestic systemically important banks. In many cases, following the identification of specific sources of systemic risk, IMF staff have also included in the FSAPs stress tests of nonbanks, such as insurance and asset management companies and nonfinancial firms, as well as estimates of stress for households. IMF staff members also provide technical assistance in stress testing to a large number of its member countries.

    IMF staff is increasingly using stress test results to support macro-prudential policy advice. Stress tests can support recommendations of micro-prudential measures, such as higher provisions or enhanced rules to related party transactions. Increasingly, recommendations of macro-prudential nature to mitigate systemic risk are also made. They include measures such as additional capital cushions, limits on credit demand (for example, debt-service-to-income ratios), and floors to capital ratios. Staff has also developed a general equilibrium model to signal when to loosen or tighten macro-prudential policy measures. The model uses macroeconomic and financial time series to derive risk measures and to assess fluctuations in default risk. It differentiates between idiosyncratic and aggregate risk. The dynamics of the model indicate that bank capital is undershooting during downturns and overshooting during booms. The model can be used to estimate nonfinancial firm and financial intermediary probabilities of default and quantify its deviation from the optimum. If risks are too high, macro-prudential policies should be tightened. On the contrary, if risks are too low, macro-prudential policies should be loosened.

    Given the likely massive financial stability challenges due to climate change, IMF staff are prioritizing the assessment of the macro-financial transmission of climate risk. Work is ongoing to examine, on a pilot basis, financial stability risks associated with the transition to a low-carbon economy. The transition risks are multifaceted and inherently hard to model. Moreover, climate change and the adjustment to a low-carbon economy are subject to fundamental uncertainty. However, an essential element in the assessment of climate risk is the availability of sufficiently detailed information. Thus, IMF supports public- and private-sector efforts to adopt climate risk disclosures across markets and jurisdictions, particularly by following the recommendations of the Task Force on Climate related Financial Disclosures (2017). A well-defined, internationally comparable taxonomy of green assets, as well as disclosure standards, would help incentivize market participants to reflect climate risks in prices. Unfortunately, disclosures are still uneven across asset classes and jurisdictions. However, a comprehensive climate stress testing would require improved provision and accessibility of high-quality data.

     

    Related Link: Policy Paper

     

    Keywords: International, Banking, Insurance, Securities, Stress Testing, Systemic Risk, Macro-Prudential Policy, Climate Change Risks, Disclosures, Big Data, IMF

    Featured Experts
    Related Articles
    News

    ISSB Sustainability Standards Expected to Become Global Baseline

    The finalization of the two sustainability disclosure standards—IFRS S1 and IFRS S2—is expected to be a significant step forward in the harmonization of sustainability disclosures worldwide.

    September 18, 2023 WebPage Regulatory News
    News

    IOSCO, BIS, and FSB to Intensify Focus on Decentralized Finance

    Decentralized finance (DeFi) is expected to increase in prominence, finding traction in use cases such as lending, trading, and investing, without the intermediation of traditional financial institutions.

    September 18, 2023 WebPage Regulatory News
    News

    BCBS Assesses NSFR and Large Exposures Rules in US

    The Basel Committee on Banking Supervision (BCBS) published reports that assessed the overall implementation of the net stable funding ratio (NSFR) and the large exposures rules in the U.S.

    September 14, 2023 WebPage Regulatory News
    News

    Global Agencies Focus on ESG Data, Climate Litigation and Nature Risks

    At the global level, supervisory efforts are increasingly focused on addressing climate risks via better quality data and innovative use of technologies such as generative artificial intelligence (AI) and blockchain.

    September 14, 2023 WebPage Regulatory News
    News

    ISSB Standards Shine Spotlight on Comparability of ESG Disclosures

    The finalization of the IFRS sustainability disclosure standards in late June 2023 has brought to the forefront the themes of the harmonization of sustainability disclosures

    August 22, 2023 WebPage Regulatory News
    News

    EBA Issues Several Regulatory and Reporting Updates for Banks

    The European Banking Authority (EBA) recently issued several regulatory publications impacting the banking sector.

    August 10, 2023 WebPage Regulatory News
    News

    BCBS Proposes to Revise Core Principles for Banking Supervision

    The Basel Committee on Banking Supervision (BCBS) launched a consultation on revisions to the core principles for effective banking supervision, with the comment period ending on October 06, 2023.

    August 04, 2023 WebPage Regulatory News
    News

    US Proposes Final Basel Rules, Transition Period to Start in July 2025

    The U.S. banking agencies (FDIC, FED, and OCC) recently proposed rules implementing the final Basel III reforms, also known as the Basel III Endgame.

    August 04, 2023 WebPage Regulatory News
    News

    FSB Report Outlines Next Steps for Climate Risk Roadmap

    The Financial Stability Board (FSB) recently published the second annual progress report on the July 2021 roadmap to address climate-related financial risks.

    August 04, 2023 WebPage Regulatory News
    News

    EBA Plans on Ad-hoc ESG Data Collection and Climate Scenario Exercise

    The recognition of climate change as a systemic risk to the global economy has further intensified regulatory and supervisory focus on monitoring of the environmental, social, and governance (ESG) risks.

    July 31, 2023 WebPage Regulatory News
    RESULTS 1 - 10 OF 8931