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

    OSFI Finalizes on Climate Risk Guideline, Issues Other Updates

    The Office of the Superintendent of Financial Institutions (OSFI) is seeking comments, until May 31, 2023, on the draft guideline on culture and behavior risk, with final guideline expected by the end of 2023.

    March 12, 2023 WebPage Regulatory News

    BIS Paper Examines Impact of Greenhouse Gas Emissions on Lending

    BIS issued a paper that investigates the effect of the greenhouse gas, or GHG, emissions of firms on bank loans using bank–firm matched data of Japanese listed firms from 2006 to 2018.

    March 03, 2023 WebPage Regulatory News

    HMT Mulls Alignment of Ring-Fencing and Resolution Regimes for Banks

    The HM Treasury (HMT) is seeking evidence, until May 07, 2023, on practicalities of aligning the ring-fencing and the banking resolution regimes for banks.

    March 02, 2023 WebPage Regulatory News

    BCBS Report Examines Impact of Basel III Framework for Banks

    The Basel Committee on Banking Supervision (BCBS) published results of the Basel III monitoring exercise based on the June 30, 2022 data.

    February 28, 2023 WebPage Regulatory News

    PRA Consults on Prudential Rules for "Simpler-Regime" Firms

    Among the recent regulatory updates from UK authorities, a key development is the first-phase consultation, from the Prudential Regulation Authority (PRA), on simplifications to the prudential framework that would apply to the simpler-regime firms.

    February 28, 2023 WebPage Regulatory News

    DNB Publishes Multiple Reporting Updates for Banks

    DNB, the central bank of Netherlands, updated the list of additional reporting requests and published additional data quality checks and XBRL-Formula linkbase documents for the first quarter of 2023.

    February 28, 2023 WebPage Regulatory News

    NBB Sets Out Climate Risk Expectations, Issues Reporting Updates

    The National Bank of Belgium (NBB) published a communication on climate-related and environmental risks, issued an update on XBRL reporting

    February 24, 2023 WebPage Regulatory News

    EBA Updates Address Securitization Standards and DGS Guidelines

    The European Banking Authority (EBA) published the final draft of the regulatory technical standards that set out conditions for assessment of homogeneity of the underlying exposures in simple, transparent, and standardized (STS) securitizations.

    February 21, 2023 WebPage Regulatory News

    FSB Publishes Letter to G20, Sets Out Work Priorities for 2023

    The Financial Stability Board (FSB) published a letter intended for the G20 Finance Ministers and Central Bank Governors, highlighting the work that FSB will take forward under the Indian G20 Presidency in 2023

    February 20, 2023 WebPage Regulatory News

    ISSB Standards May Become Effective from January 2024

    The International Organization of Securities Commissions (IOSCO) welcomed the confirmation statement by the International Sustainability Standards Board (ISSB) setting out its progress in the development of its first sustainability-related corporate disclosure standards.

    February 17, 2023 WebPage Regulatory News
    RESULTS 1 - 10 OF 8792