Banking regulators are moving closer to including climate-related capital and liquidity requirements in their prudential standards, following the release of climate risk management guidelines by the Basel Committee on Banking Supervision that include capital adequacy principles.
The BCBS published a set of 18 principles for the effective management and supervision of climate-related financial risks in June. They cover governance, internal controls, risk assessment, management and reporting.
The BCBS said it expects to see implementation of the principles and it will monitor progress.
APRA’s current guidance is in the form of a practice guide, CPG 229 Climate Change Financial Risks, which is not binding regulation. But that looks set to change.
Despite their reassurances that they are making great strides in this area, it looks like Australian banks have a lot of work to do.
Last month, a member of the European Central Bank executive board, Frank Elderson, reported on the progress European banks are making implementing climate risk management frameworks. Elderson chaired the committee that produced the BCBS principles, which are closely aligned with ECB expectations.
Elderson said: “Clear gaps remain in all areas of focus and individual banks are not making progress across the board.”
On capital and liquidity adequacy, the BCBS said banks should start building risk analysis capabilities by identifying relevant climate-related risk drivers that may materially impair their financial condition.
They should have clear definitions and thresholds for materiality.
Banks should develop processes to evaluate the solvency impact of climate-related financial risks that may materialise within their capital planning horizons.
Banks should include climate-related financial risks assessed as material over relevant time horizons that may negatively affect their capital position in their internal adequacy assessment process.
They should assess whether climate-related risk could cause net cash outflow or depletion of liquidity buffers.
The BCBS said it recognised climate-related financial risks would probably be incorporated into banks’ internal capital and liquidity adequacy assessments iteratively and progressively.
It recommended regulators review the extent to which banks regularly assess the materiality of climate-related financial risks and, where applicable, risk mitigation measures.
And it said regulators should use climate-related risk scenarios and consider the use of stress testing to assess the adequacy of a bank’s risk management approaches and evaluate its financial position under severe but plausible scenarios.
The committee said its guidance for supervisors and banks aimed to set a baseline, while retaining enough flexibility to allow for different circumstances and evolving practices.
The guidance is principles based. Banks should manage climate related financial risks in a manner that is proportionate to the nature, scale and complexity of their activities.
APRA’s work in this area includes the release last November of a practice guide on managing climate change financial risks, CPG 229 Climate Change Financial Risks.
While the practice guide is not binding, 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