Featured Product

    FSI Paper Examines Practices for Climate Risk Stress Testing of Banks

    July 14, 2021

    The Financial Stability Institute (FSI) of Bank for International Settlements (BIS) published a paper that examines the key design features of a climate risk stress test for banks and discusses the challenges that emerge when trying to adapt traditional stress tests to banks' climate-related risks. The paper reviews how the identified challenges have been addressed in practice and concludes with reflections about the possible implications for prudential requirements of addressing climate risk. The identified challenges relate to data availability and reliability, adoption of very long time horizons, uncertainty around future pathways of key reference variables covering physical risks, and uncertainty related to transition risks. The paper concludes that methodological changes are needed to make stress tests better suited for climate risks; it also notes that modeling approaches need to be revised to include a climate risk component and to allow for finer sectoral and geographical breakdowns.

    The paper shows how the technical challenges of a climate risk stress test have been addressed in pilot exercises conducted by the Dutch and French authorities in 2018 and 2021, respectively, and in the exercise underway in the UK. These pilots are seen as highly relevant by the authorities and the industry. They are being viewed as a starting point for managing climate-related risks and are expected to be useful in the beginning to identify and assess an increasingly important source of risk. They can also act as a catalyst to further develop modeling techniques that would be better suited to capturing climate risk and to the collection of relevant data. At a minimum, climate stress test exercises, and the ways in which a bank acts on their outcomes, can inform discussions with its supervisor regarding its business model, internal governance, and risk management. However, at this stage the stress tests are considered to be exploratory and preliminary and it is clearly acknowledged that much remains to be improved. 

    An open issue for all authorities is the nature of their follow-up with the industry, although for now climate stress tests are not expected to trigger new capital requirements. Bank stress tests have traditionally been associated with setting a minimum level of capital for each bank and requirements for remedial action when the hurdle rate is not met. For climate risk-related exercises such a requirement is considered premature given the preliminary nature of the exercises and the high-level of uncertainty attached to their results. For this reason, some authorities prefer to describe their current exercises as “scenario analysis” rather than “stress tests.” Irrespective of the labeling, the predominant view in the official community is that no new capital requirements will be introduced on the basis of the outcomes of these stress tests. The outcome of climate change stress tests may inform other supervisory actions. Public communication by authorities engaging in such exercises indicates that they plan to use the exercises in supervisory reviews and supervisory expectations have been set accordingly. Thus, the climate stress test exercises, and the ways in which they inform banks’ decisions regarding their business models and their day-to-day risk management, can become the basis of supervisory discussions; they can facilitate a smooth transition for the banks to a lower carbon economy. Ultimately, such stress tests also contribute to the safety and soundness of the financial system.


    Related Links

    Keywords: International, Banking, Climate Change Risk, Stress Testing, Transition Risk, Physical Risk, ESG, Scenario Analysis, Regulatory Capital, BIS

    Featured Experts
    Related Articles

    EBA Proposes Standards for IRRBB Reporting Under Basel Framework

    The European Banking Authority (EBA) proposed implementing technical standards on the interest rate risk in the banking book (IRRBB) reporting requirements, with the comment period ending on May 02, 2023.

    January 31, 2023 WebPage Regulatory News

    FED Issues Further Details on Pilot Climate Scenario Analysis Exercise

    The U.S. Federal Reserve Board (FED) set out details of the pilot climate scenario analysis exercise to be conducted among the six largest U.S. bank holding companies.

    January 17, 2023 WebPage Regulatory News

    US Agencies Issue Several Regulatory and Reporting Updates

    The Board of Governors of the Federal Reserve System (FED) adopted the final rule on Adjustable Interest Rate (LIBOR) Act.

    January 04, 2023 WebPage Regulatory News

    ECB Issues Multiple Reports and Regulatory Updates for Banks

    The European Central Bank (ECB) published an updated list of supervised entities, a report on the supervision of less significant institutions (LSIs), a statement on macro-prudential policy.

    January 01, 2023 WebPage Regulatory News

    HKMA Keeps List of D-SIBs Unchanged, Makes Other Announcements

    The Hong Kong Monetary Authority (HKMA) published a circular on the prudential treatment of crypto-asset exposures, an update on the status of transition to new interest rate benchmarks.

    December 30, 2022 WebPage Regulatory News

    EU Issues FAQs on Taxonomy Regulation, Rules Under CRD, FICOD and SFDR

    The European Commission (EC) adopted the standards addressing supervisory reporting of risk concentrations and intra-group transactions, benchmarking of internal approaches, and authorization of credit institutions.

    December 29, 2022 WebPage Regulatory News

    CBIRC Revises Measures on Corporate Governance Supervision

    The China Banking and Insurance Regulatory Commission (CBIRC) issued rules to manage the risk of off-balance sheet business of commercial banks and rules on corporate governance of financial institutions.

    December 29, 2022 WebPage Regulatory News

    HKMA Publications Address Sustainability Issues in Financial Sector

    The Hong Kong Monetary Authority (HKMA) made announcements to address sustainability issues in the financial sector.

    December 23, 2022 WebPage Regulatory News

    EBA Updates Address Basel and NPL Requirements for Banks

    The European Banking Authority (EBA) published regulatory standards on identification of a group of connected clients (GCC) as well as updated the lists of identified financial conglomerates.

    December 22, 2022 WebPage Regulatory News

    ESMA Publishes 2022 ESEF XBRL Taxonomy and Conformance Suite

    The General Board of the European Systemic Risk Board (ESRB), at its December meeting, issued an updated risk assessment via the quarterly risk dashboard and held discussions on key policy priorities to address the systemic risks in the European Union.

    December 22, 2022 WebPage Regulatory News
    RESULTS 1 - 10 OF 8699