U.S. shows no sign of introducing such measuresNew market research from Fitch ratings considers banks’ financial performance through “physical” risks and “transition” risks. Visit here for more information
Fitch Ratings-London-10 September 2020 — Climate-change stress tests will eventually feed into prudential capital requirements for European banks, Fitch Ratings says in a new report. EU and UK supervisors appear the most advanced in efforts to quantify the assessment of climate risks to banks, although Japan has recently unveiled climate-risk stress tests for its largest banks, according to media reports.
The ECB is the only regulator to make clear that climate scenario analysis and stress testing should explicitly feed into banks’ capital adequacy. We believe this is to help drive the European Green Deal, which aims targets climate neutrality for the EU by 2050.
The US, meanwhile, shows no sign of introducing climate-risk stress tests for its banks.
Bank Awareness Of Climate Risk Impacts On Financial Markets
French and UK banking regulators are among the first to require stress tests for climate change, which we believe will make banks more aware of how climate risk can increase other types of risk, including credit, market, business and reputational risk. Greater awareness should help to drive banks’ sustainability objectives, and while the French and UK stress tests will not formally test banks’ capital adequacy, we expect that climate-change risks will eventually feed into prudential capital requirements across Europe.
French and UK banks will run exploratory 30-year climate-change scenarios set out by the Banque de France and the Bank of England respectively. The banks will use their own data for this, under a “bottom-up” approach, and we expect results to be available in April 2021 for French banks and in 2022 for UK banks. Quantifying the extent of potential climate-related disruption to revenue, asset values and capital is integral to the tests.
Valuation For The ‘Pillar 2’ Risks
The French and UK exercises will not formally test banks’ capital adequacy nor be used to set capital requirements, but it is likely that the outcomes will influence how much capital banks need to set aside for Pillar 2 risks. The ECB is already guiding the large banks that it directly supervises to incorporate climate risks into their Pillar 2 capital adequacy assessments, and the European Banking Authority is considering including climate-change sensitivities in the 2021 EU-wide stress tests for the first time. We believe outputs from climate stress tests will gradually be incorporated into capital requirements across Europe.
Climate change could affect banks’ financial performance through “physical” risks and “transition” risks. Physical climate-related risks are events that could disrupt business, such as droughts, floods and fires, as well as longer-term changes in weather patterns that could affect rainfall, sea levels and temperatures. Transition climate-related risks arise from the transition to a low-carbon economy, which could affect banks’ asset quality through reduced public sentiment towards certain sectors or the write-down of carbon-intensive assets.
The report “Bank Climate-Change Stress Tests” is available at www.fitchratings.com or by clicking the link above.