Abstract
This article reviews emerging regulatory and supervisory practices with respect to prudential risks from climate change in the banking sector. It evaluates the theoretical considerations with respect to climate-related financial risks in the banking sector, reviews the related academic literature, and analyzes the policy-related publications from various regulatory authorities. As a result of this assessment, the article concludes that the major regulatory and supervisory expectations can be categorized into four key areas: (i) board-level attention to climate risks and integrating them into internal governance frameworks, (ii) embedding climate risks into strategies and overall risk management frameworks, (iii) identifying climate-related material exposures and disclosure of relevant key metrics, and (iv) assessing capital impact from climate risk through scenario analysis and stress testing. The article also presents a number of implications for banks and banking regulators in other jurisdictions to help them identify the actions required to address climate change risks in the banking sector.
Highlights
Climate-related financial risks have started to intensify both at the micro and macro levels over the last decade
There is a small body of literature which focuses on the financial risks from climate change in the banking sector due to shortage of empirical evidence
In the spirit of the Senior Managers & Certification Regime (SM&CR) principles, the Prudential Regulation Authority (PRA) expects banks to define clear responsibilities and accountabilities within their internal governance frameworks, ensuring that they have in place clear ownership of the climate change-related financial risks as well as the overall responsibility for setting the strategy, targets, and risk appetite relating to these risks at board level
Summary
Climate-related financial risks have started to intensify both at the micro and macro levels over the last decade. Climate-related claims burden is expected to increase up to over 100% by 2085 in the insurance sector due to more frequent climate events and sea level rise [1] This has important implications for the financial system. The Prudential Regulation Authority (PRA) considers that the physical and transition risk factors from climate change have distinctive aspects that can be summarized as in Table 1 below These aspects are relevant from a financial stability perspective, in addition to bank-level considerations. The PRA considers that the impact of these risks will by and large depend on short-term policy actions and they present banking regulators and central banks with unique challenges, as they have unique and distinctive characteristics separating them from other types of financial stability risks. It is evident that the identification, assessment, and management of these risks require a holistic, strategic, and concerted effort from all central banks, regulators and financial institutions
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