2. Theoretical Considerations on the Financial Impact of Climate Change in the Banking Sector
2.1. Physical Risks That may Arise from Shifts in Climate Patterns
2.2. Transition Risks from Adjustment towards a Carbon-Neutral Economy
3. Review of the Academic Literature
4. Emerging Regulatory and Supervisory Expectations with Respect to Climate-Related Financial Risks
4.1. Emerging Global Regulatory and Supervisory Expectations
- Outlining supervisory plans on deliverables and activities related to climate change risks;
- Encouraging financial institutions to take actions in governance, risk management, and disclosure of climate-related exposures and financial risks;
- Providing guidance on how to properly integrate climate-related financial risks within risk management;
- Requiring banks to increase credit availability to ‘green’ and ‘low carbon’ sectors.
4.2. Emerging National Regulatory and Supervisory Expectations
- Board-level attention to climate risks and integrating them into internal governance frameworks
- Embedding climate risks into strategies and overall risk management frameworks
- Identifying material exposures to climate risks and disclosure of relevant key metrics
- Assessing capital impact from climate risks through scenario analysis and stress testing
4.3. Prudential Risks from Climate Change and Proposed Measures
5. Impact of Climate Change Mitigation Policies and Regulatory Expectations on Banks
5.1. Board-Level Attention to Climate Risks and Integrating them into Internal Governance Frameworks
5.2. Embedding Climate Risks into Strategies and Overall Risk Management Frameworks
5.3. Identifying Material Exposures and Disclosure of Key Metrics
- Internal governance and board oversight
- Climate risk related risks and opportunities
- Resilience of bank’s business strategy to climate-related scenarios
- Financial planning with respect to climate risks
- Integration into banks’ overall risk management framework
- Processes to identify, assess, and manage climate risk disclosures
- Corporate targets with respect to climate risks
- Metrics such as a bank’s own carbon emissions and greenhouse gas metrics
- Transition risks in the bank’s lending and investment portfolio
- Physical risks to banks assets and investments
- Financing of green growth sectors
- Reputational risks with respect to climate risks
- Compliance with the ESG factors
- Level of lending to high-risk sectors
5.4. Assessing Capital Impact through Scenario Analysis and Stress Testing
6. Conclusions and Policy Implications
Conflicts of Interest
Appendix A. The Prudential Regulation Authority’s Survey on the Impact of Climate Change on the UK Banking Sector (for Details See ).
- the achievement of your firm’s business plan;
- the continued safety and soundness of your firm; and/or
- the protection of your shareholders/investors/deposit holders.
- Assets linked to sectors and projects with high carbon business models to estimate potential losses in the event of a rapid transition to a lower carbon economy (i.e., transition risk)? YES/NO
- Assets linked to sectors, regions, and clients particularly vulnerable to climate-related events, such as storms, floods, or drought? (YES/NO) If yes, please provide further information.
Appendix B. Stock Take Questionnaire Conducted by the Basel Committee’s Task Force on Climate-Related Financial Risks (for Details See ).
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|Far-reaching in breadthand magnitude||The financial risks from physical and transition risk factors are relevant to multiple lines of business, sectors, and geographies. Their full impact on the financial system may therefore be larger than for other types of risks, and is potentially non-linear, correlated, and irreversible.|
|Uncertain and extendedtime horizons||The time horizons over which financial risks may be realized are uncertain, and their full impact may crystallize outside of many current business planning horizons (tragedy of the horizon). Using past data may not be a good predictor of future risks.|
|Foreseeable nature||While the exact outcome is uncertain, there is a high degree of certainty that financial risks from some combination of physical and transition factors will occur.|
|Dependency on short-term actions||The magnitude of future impact will, at least in part, be determined by the actions taken today. This includes actions by governments, financial market participants, and a range of other actors.|
|Physical Risks||Transitional Risks|
|Changes in temperature||Higher carbon prices|
|Water scarcity and extended droughts||Limits on carbon emissions|
|Cyclones, hurricanes, and typhoons||Higher taxes on carbon-intensive technologies|
|Floods in residential areas and farmlands||Subsidies to low-carbon alternatives|
|Sea level rise in coastal areas||Ban on carbon-intensive products|
|Wildfires that affect populated areas||Ban on carbon-intensive technologies|
|Country||Relevant Authority||Regulatory or Supervisory Expectation|
|Australia||Australian Prudential Regulation Authority||Banks are encouraged to consider climate risks within their wider risk-management frameworks. In 2019, they conducted a survey of financial firms to gauge their awareness of climate risk and identify industry best practice.|
|Bangladesh||The Bangladesh Bank||Updated Environmental Risk Management Guidelines were issued in 2017.|
|Brazil||The Central Bank of Brazil||A Resolution on Social and Environmental Responsibility for Financial Institutions was issued in 2014.|
|Canada||The Bank of Canada||Climate change risk has been included in the analysis of the Canadian financial system. It has also published a Climate Change Scenario Analysis study in 2020.|
|China||The China Banking Regulatory Commission||The Green Credit Guidelines were issued in 2012 as well as the Green Credit Statistics System and Key Performance Indicators in 2014.|
|Colombia||Colombian Banking Association||The Colombia Green Protocol was signed in 2012 and the Guideline on Environment and Sustainability Risk Management was launched in 2016.|
|Ecuador||The Banking Association of Ecuador||The Sustainable Finance Protocol was signed in 2016.|
|EU||The European Commission andthe European Banking Authority||The adoption of a Green Supporting Factor is under discussion. Member states are supportive as per their commitment to the energy transition. It is also being assessed whether a specific prudential regulation should be implemented for green assets.|
|Indonesia||The Indonesia Financial Services Authority||The Roadmap for Sustainable Finance was published in 2014.|
|Kenya||Kenya Bankers Association||The Sustainable Finance Initiative Guiding Principles were announced in 2015.|
|Mexico||Mexican Banking Association||The Sustainability Protocol was signed in 2016.|
|Morocco||The Central Bank of Morocco||The Roadmap for Aligning the Moroccan Financial Sector with Sustainable Developments was announced in 2016.|
|Netherlands||The De Nederlandsche Bank||Climate risk has been incorporated into supervisory framework and stress testing. The first climate-related stress testing was conducted in 2018.|
|New Zealand||The Reserve Bank of New Zealand||A Climate Change Strategy was announced in 2018 to ensure that New Zealand’s transition to a low-carbon economy does not adversely impact financial stability.|
|Nigeria||The Central Bank of Nigeria||The Nigerian Sustainable Banking Principles were published in 2012.|
|Peru||The Superintendency of Banking, Insurance and Private Pension Fund Administrators of Peru||The Regulation for Social and Environmental Risk Management was announced in 2015.|
|Singapore||The Monetary Authority of Singapore||Banks are required to integrate sustainability risks into their risk management frameworks. The regulator plans to include climate-related scenarios in industry-wide stress tests.|
|South Africa||Banking Association South Africa||Voluntary Principles on Environmental and Sustainability Risk Management were published in 2014.|
|Turkey||Banks Association of Turkey||Voluntary Sustainability Guidelines were published in 2014.|
|UK||The Prudential Regulation Authority (Bank of England)||Climate risk have already been incorporated into prudential supervisory framework in 2019. Climate risk scenarios will be included in the sector-wide stress tests as part of the 2021 exploratory scenario.|
|USA||The Commodity Futures Trading Commission and the Securities and Exchange Commission||Supervisors have started expressing their supervisory expectations that banks should incorporate climate risks into their internal risk management frameworks. They have begun to expect disclosures with respect to climate risks.|
|Vietnam||The State Bank of Vietnam||The Directive on Promoting Green Credit and Managing Environmental and Social Risk in Lending Activities was published in 2015.|
|Risk type||Examples of Climate-related Factors Affecting Prudential Risks|
|Credit risk||The destruction of a production site by wildfire can increase the probability of default of the company operating the site. Loss stemming from default of mortgage-backed loans can increase when the value of buildings provided as collateral decreases due to new energy-efficiency standards.|
|Operational risk||Extreme weather events can have an impact on financial institutions’ business continuity through, for instance, damage affecting critical functions of the financial entity or of its main providers. Financial institutions or their customers might face a liability charge from parties who have suffered losses from physical and transition effects and seek to recover these losses from those they view as responsible.|
|Market risk||Severe weather events or political measures regarding the transition could lead to re-pricing of financial instruments and corporate debt, affecting the value of securities held on financial institutions’ balance sheets (and/or the value of collateral used in some operations). The introduction of a carbon tax can result in investment losses and lower assets’ values (stranded assets).|
|Liquidity risk||A lack of reliable and comparable information on climate-sensitive exposures of financial institutions could create uncertainty and cause procyclical market dynamics, including fire sales of carbon-intensive assets, and potentially also liquidity problems.|
|Example Action||What Should Firms Do?|
|Deepening understanding of the financial risks from climate change|
|Agreeing a board-level firm-wide strategic response|
|Considering how decisions today affect future financial risks|
|Risk||Prudential Risk Area|
|Credit risk||Market risk||Operational risk|
|Physical risk||Increasing flood risk to mortgage portfolio;Declining agricultural output increases default rates||Severe weather events lead to re-pricing of sovereign debt||Severe weather events impact business continuity|
|Transition risk||Tightening energy efficiency standards impact property exposures;Stranded assets impair loan portfolios;Disruptive technology leads to auto finance losses||Tightening climate-related policy leads to repricing of securities and derivatives||Changing sentiment on climate issues leads to reputational risks|
|Climate Risk Variables||Macrofinancial Variables|
|Physical variables||Transitional variables||Macroeconomic variables||Financial market variables|
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