14 Jul BCBS – Stress-testing banks for climate change
July 14, 2021 – Financial authorities increasingly require the financial industry to assess climate risks. Launched stress tests for banks, more exercises are planned for the near future. The use of stress tests is an important step in dealing with climate risks as these tests are useful for sizing, even if only approximately, potential impacts of climate risks. Challenges arise from adapting traditional stress tests to banks’ climate-related risks.
Challenges related to data availability, reliability, and adoption of long-time horizons. Uncertainty around future pathways of key reference variables covering physical risks (floods, temperature increases, and rising sea levels) and transition risks (changes in climate policies, technologies, or consumer preferences). The paper discussed how the modeling approaches need to be revised to include a climate risk component and to allow for finer sectoral and geographical breakdowns. Reviews how challenges have been addressed using three recent tests for climate risk. Reflects on possible implications for prudential requirements of addressing climate risk.
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