Banks and other financial institutions will be expected to monitor and record any material impact of climate risk on capital adequacy, under the new climate guidance issued by the Australian Prudential Regulation Authority.
On Friday, APRA released a finalised practice guide on managing climate change financial risks, CPG 229 Climate Change Financial Risks.
APRA’s prudential practice guides are not legally binding regulations and CPG 229 imposes no new regulatory requirements. It is designed to be “helpful guidance” as to how regulated entities can fulfil their prudential obligations.
However, APRA made it clear that part of its purpose is to prompt regulated entities “to move more swiftly from awareness to action, to ensure institutions are equipped to adapt and respond to the substantial changes in the international economic and regulatory environment that are in train.”
The guide draws on aspects of the work of the Task Force on Climate-related Financial Disclosures, which was set up by the Financial Stability Board in 2015, and the Network for Greening the Financial System, a group of 83 central banks, standard-setting bodies and financial regulators.
APRA has made its view clear for several years that climate-related risks are financial in nature and that they are “foreseeable, material and actionable.”
Risks include credit risk, market risk, operational risks, insurance risk, liquidity risk and reputational risk.
At the core of the new guidance are climate vulnerability assessments, which are aimed at understanding the vulnerability of institutions and how they can adjust their business models in response to the challenges proposed by different scenarios.
APRA expects regulated entities to develop advanced quantitative risk metrics to measure and monitor risks, and have plans to manage exposures and mitigate risks.
The guidance emphasises the importance of disclosure to stakeholders.
On capital, it says it is appropriate for an institution “to consider and record any material impact on capital adequacy as a result of climate risks. An institution may choose to use the Internal Capital Adequacy Assessment Process (ICAAP) for this purpose.
“An institution that is not required to complete an ICAAP may benefit from adopting a similar approach to recording any material exposures and how the assessment of those exposures is considered, for example within stress testing policies and processes.”