Multiple layers of uncertainty on the course of climate change give rise to a lack of consistent data and methodologies for translating potential outcomes into financial exposure estimates.
The FSB (Financial Stability Board) has published a stocktake of 33 financial authorities’ experience in including climate-related risks in financial stability monitoring.
The stocktake finds that more almost three-quarters (72%) of authorities surveyed consider, or are planning to consider, climate-related risks as part of their financial stability monitoring. Of these, 18 respondents report including physical risks as part of their monitoring work, while 13 report including transition risks – in part due to greater data availability on physical risks.
Most authorities considering climate-related risks as part of their monitoring work focus on the implications of changes in asset prices and credit quality. Some authorities also consider the implications for underwriting, legal, liability and operational risks.
In considering the implications of these risks for financial institutions, the FSB says for considerations of the implications of credit and market risks faced by banks and insurance firms are the most advanced – compared to other risks, and compared to risks faced by other types of financial institutions.
According to the report, only seven respondent authorities consider how climate-related risks to the financial system might feedback to the real economy, and thereby further affect the financial system. Meanwhile, only eight consider – or recognised the importance of considering in future – the potential for spillovers across borders or between financial sectors.
While some financial authorities have quantified – or have work underway to quantify – climate-related risks, such work is hindered by a lack of consistent data on financial exposures to climate risks, and difficulties translating climate change outcomes into changes in those exposures, the report says.
“No approach to quantification provides a holistic assessment of climate-related risks to the global financial system. Neither is there currently a consistent methodology for the assessment of climate risks that can assess cross-border spillovers.”
According to the FSB, multiple layers of uncertainty on the course of climate change give rise to a lack of consistent data and methodologies through which to translate potential outcomes into estimates of financial exposures.
Despite these difficulties, some jurisdictions are integrating climate-related risks into microprudential supervision of banks and insurance firms, including via stress testing and disclosure requirements for firms, though this work is said to be at an early stage.
Some authorities have set out – or are in the process of setting out – their expectations on how financial institutions should be monitoring, managing and disclosing climate-related risks.
In some cases, disclosure expectations explicitly refer to the recommendations of the FSB’s TCFD (Task Force on Climate-related Financial Disclosures). The next status report on TCFD adoption will be published in November.
In light of the FSB’s findings, it will conduct further work by October 2020 to assess the channels through which physical and transition risks could impact the financial system and how they might interact. This work will focus on potential amplification mechanisms and cross-border effects, prioritising channels that could materialise in the short-to-medium term.
The FSB will also consider the scope for work to assess available data through which climate-related risks can be monitored, as well as data gaps.
The full report is available here.