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APAC Banks: Climate Risk Stress Tests Primer
Pramod Shenoi – Co-Head of Asia-Pacific Research
Lim Ze Hao – Analyst - Asia-Pacific Banks
EXECUTIVE SUMMARY
- Many central banks and supervisory authorities around the world have begun or intend to start climate risk stress tests (“CRSTs”) on financial institutions.
- In this primer, we provide an overview of CRSTs and compare the relative progress made by the 11 different APAC jurisdictions that we cover, as well as highlight key results of those that have completed their first iterations.
- Transition risk mainly arises from the banks’ exposure to carbon-intensive sectors, as these sectors will bear the brunt of higher carbon prices during the world’s transition to a low carbon economy. Sectors that are most vulnerable include thermal energy, mining, energy intensive manufacturing, and transportation.
- Physical risk impacts are harder to quantitatively capture by current methods, but are closely related to geolocation; CRSTs in several jurisdictions for instance showed significantly higher mortgage lending losses in regions that are more exposed to extreme and prolonged physical risks.
- Credit losses and the impact on bank capital ratios from climate risk have been found to be generally manageable for financial institutions thus far, but caution is warranted in interpreting the results as CRSTs may underestimate the potential losses due to various limitations at present.
- Foremost among the limitations are data gaps, particularly on borrowers’ carbon emissions, as well as significant estimation uncertainty in modelling the losses that arise from climate risk, which is made more difficult by the long time horizon (~30-80 years) of CRSTs. Methods of risk analysis and the many assumptions needed vary across financial institutions, giving rise to results that are wide-ranging at times and not directly comparable.
- As such, CRSTs have mostly been declared as learning exercises and do not impact capital requirements for now except for certain EU banks; however, we expect that CRSTs may eventually feature in banks’ annual stress tests and carry additional capital charges as methods get refined and standardized and comparable CRSTs are developed.
- Among our 11 covered APAC jurisdictions, Australia, Japan, South Korea, Hong Kong, China, Singapore and India have completed at least one iteration and published the results; Indonesia’s pilot exercise appears to be underway and Malaysia’s will start in 2024. The Philippines has indicated that it plans to rollout a pilot exercise soon, while we have not seen any developments from Thailand.
Many central banks and supervisory authorities around the world have begun or intend to start climate risk stress tests (“CRSTs”) on financial institutions. In this primer, we provide an overview of CRSTs and highlight the general findings, current challenges and future implications in this space. We then compare the relative progress made by the 11 different APAC jurisdictions that we cover, and highlight the key results from those that have completed first iterations of CRSTs.
OVERVIEW OF CLIMATE RISK STRESS TESTS (CRSTS)
Climate risk is increasingly being recognized by regulatory authorities as a driver of traditional financial risks such as credit and market risks. The Task Force for Climate-Related Financial Disclosures (TCFD) of the Basel Committee on Banking Supervision (BCBS) separates climate risk into two distinct categories:
- Physical risk: Arises from weather and climate events, and can be further classified into risks caused by severe natural disasters (acute physical risk), and those caused gradually by long-term changes in climate patterns arising from a rise in temperature and sea levels (chronic physical risk).
- Transition risk: Arises from society’s transition to a low carbon emissions economy, which may entail policy and legal, technology, market and reputation risks. These can take the form of policy changes, uncertainty in the progress of development of new and cheaper low carbon technologies, as well as shifts in investor preferences and consumer behavior.
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