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

    PRA Finalizes Supervisory Approach for Non-Systemic Banks in UK

    PRA published the policy statement PS8/21, which contains the final supervisory statement SS3/21 on the PRA approach to supervision of the new and growing non-systemic banks in UK.

    April 15, 2021 WebPage Regulatory News
    News

    EBA Finalizes Standards on Methods of Prudential Consolidation

    EBA published a report that sets out the final draft regulatory technical standards specifying the conditions according to which consolidation shall be carried out in line with Article 18 of the Capital Requirements Regulation (CRR).

    April 15, 2021 WebPage Regulatory News
    News

    EBA Updates List of Other Systemically Important Institutions in EU

    EBA updated the list of other systemically important institutions (O-SIIs) in EU.

    April 15, 2021 WebPage Regulatory News
    News

    BCBS Report Concludes Basel Risk Categories Can Capture Climate Risks

    BCBS published two reports that discuss transmission channels of climate-related risks to the banking system and the measurement methodologies of climate-related financial risks.

    April 14, 2021 WebPage Regulatory News
    News

    UK Authorities Welcome FSB Review of their Remuneration Regime

    UK Authorities (FCA and PRA) welcomed the findings of FSB peer review on the implementation of financial sector remuneration reforms in the UK.

    April 14, 2021 WebPage Regulatory News
    News

    PRA and FCA Letter on Addressing Risks from Use of Deposit Aggregators

    PRA and FCA jointly issued a letter that highlights risks associated with the increasing volumes of deposits that are placed with banks and building societies via deposit aggregators and how to mitigate these risks.

    April 14, 2021 WebPage Regulatory News
    News

    MFSA to Amend Banking Act and Rules in Coming Months to Transpose CRD5

    MFSA announced that amendments to the Banking Act, Subsidiary Legislation, and Banking Rules will be issued in the coming months, to transpose the Capital Requirements Directive (CRD5) into the national regulatory framework.

    April 14, 2021 WebPage Regulatory News
    News

    EC Delegated Regulation on Specialized Lending Exposures Under CRR

    EC finalized the Delegated Regulation 2021/598 that supplements the Capital Requirements Regulation (CRR or 575/2013) and lays out the regulatory technical standards for assigning risk-weights to specialized lending exposures.

    April 14, 2021 WebPage Regulatory News
    News

    OSFI Proposes to Enhance Assurance Expectations for Basel Returns

    OSFI launched a consultation to explore ways to enhance the OSFI assurance over capital, leverage, and liquidity returns for banks and insurers, given the increasing complexity arising from the evolving regulatory reporting framework due to IFRS 17 (Insurance Contracts) standard and Basel III reforms.

    April 13, 2021 WebPage Regulatory News
    News

    ECB Issues Results of Benchmarking Analysis of Recovery Plans of Banks

    ECB published results of the benchmarking analysis of the recovery plan cycle for 2019.

    April 13, 2021 WebPage Regulatory News
    RESULTS 1 - 10 OF 6858