The Australian Prudential Regulation Authority (APRA) published an information paper presenting the findings of the first Climate Vulnerability Assessment, which was conducted among five larges banks in Australia. This analysis provides insights into the potential financial exposure of institutions, the financial system, and economy to the physical and transition risks of climate change. It is also expected to help in improving climate risk management at banks and in understanding how banks may adjust the business models and implement management actions in response.
APRA, on behalf of the Council of Financial Regulators (CFR), conducted the Climate Vulnerability Assessment in 2021-2022 to assess the nature and extent of climate risks at financial institutions. The five participating banks were Australia and New Zealand (ANZ) Banking Group, Commonwealth Bank of Australia, Macquarie Bank, National Australia Bank, and Westpac Banking Corporation. The participating banks modeled climate risk impact using two internationally recognized scenarios developed by the Network for Greening the Financial System (NGFS). The two future climate scenarios used were a Delayed Transition Scenario, which explores a future with delayed policy action on climate change, followed by a rapid reduction in global emissions after 2030, and a Current Policies Scenario, which explores a future with continued increase in global emissions beyond 2050.
The results of this climate risk assessment suggest that, for the climate scenarios assessed, physical and transition risks would increase overall bank lending losses in the medium-to-long term. Although the impact is not expected to cause severe stress to the banking system, climate change could lead to the banking sector being more vulnerable to future economic downturns. The results also indicate that the impact of climate risk is likely to be concentrated in specific regions and industries. For example, mortgage lending losses were higher in northern Australia, while bank losses were higher from lending to business sectors that are more exposed to transition risks, such as mining, manufacturing, and transport. In response to these potential losses, the banks predicted that they would adjust their risk appetites and lending practices, such as cutting back on high loan-to-valuation lending and reducing their exposure to higher risk regions and industries. The assessment also highlighted the interconnected nature of climate risk across financial institutions from different sectors and the need for this to be considered in scenario analysis initiatives. It is to be noted that several international regulators have undertaken some form of climate-related scenario analysis and that climate scenario analysis is increasingly integrated into international standards and guidance, such as the Basel Committee on Banking Supervision’s (BCBS) Principles for the Effective Management and Supervision of Climate-related Financial Risks.
Similarly, financial regulators in Australia are increasingly adopting climate scenario analysis and modeling to identify and assess the financial impact of climate change. Through CFR, the Reserve Bank of Australia (RBA) outlined its plans to conduct further analysis of climate risks to the financial system, drawing on the scenario development undertaken through the Climate Vulnerability Assessment. RBA will also support the work of APRA by extending its own analysis of climate risk to include both banks and insurers while the Treasury is investing in expanding its climate modeling capability, including assessing the impact of climate change on the economic and fiscal outlook. Meanwhile, the Australian Securities and Investments Commission (ASIC) plans to continue to work on improving standards of climate-related governance and disclosure by listed companies. Going forward, APRA, together with the CFR agencies, will consider how the experience gained from the Climate Vulnerability Assessment may be applied to similar activities in other sectors, including insurance, superannuation, and the broader banking sector.
Keywords: Asia Pacific, Australia, Banking, ESG, Climate Change Risk, Lending, Credit Risk, Stress Testing, Mortgage Lending, Disclosures, NGFS Scenarios, Scenario Analyses, APRA
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