Climate risk and bank stress testing

Posted on July 23, 2021 by Editor

The Financial Stability Institute (FSI) has published an Insights paper on ‘Stress-testing banks for climate change risk – a comparison of practices.’

With global and national authorities increasingly requiring the financial industry to assess and manage climate risks, relevant stress tests are increasingly being planned and launched as a tool to understand potential impacts. The paper examines the challenges that emerge in adapting traditional stress tests to climate risk, and examples from France, the Netherlands and the UK of how these have been addressed in practice, finding that some methodological adaptations are needed. The challenges are broad in scope, relating 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.

Reflecting on the possible implications for prudential requirements of addressing climate risk, the paper concludes that climate stress test exercises are likely to form the basis of other supervisory discussions and decision making in areas such as bank business models, internal governance and risk management. Of course, this gives a substantial importance to reporting and modelling methodologies, data quality, and a careful consideration of the inherent uncertainties.

Read more here.

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