Basel Committee publishes analytical reports on climate-related financial risks

The Basel Committee on Banking Supervision published two analytical reports entitled Climate-related risk drivers and their transmission channels and Climate-related financial risks – measurement methodologies which are intended to be read in tandem. Both reports leverage extensive reviews of existing literature, including publications by scientists, academics, central banks, supervisory authorities, discussions with large banks, and the work of other international forums such as the Network for Greening the Financial System and the Financial Stability Board.

The first report specifically explores how climate-related risk drivers, such as physical risks and transition risks, can arise and affect both the banks and the banking system via micro- and macroeconomic transmission channels. It addresses various points :

  • The economic and financial market impacts of climate-related risks can vary according to geography, sector and economic and financial system development.
  • Traditional risk categories used by financial institutions and reflected in the Basel Framework (eg credit risk, market risk, liquidity risk, operational risk) can be used to capture climate-related financial risks.
  • There is limited research and accompanying data that explore how climate-related risks feed into the traditional risks faced by banks. A better understanding of climate risk drivers and their impact on banks’ exposures across all risk types would be gained from further research by a broader community.

The second report provides an overview of conceptual issues related to climate-related financial risk measurement and methodologies, and describes banks’ and supervisors’ current and emerging practices in this area. It outlines how:

  • Climate-related financial risks entail unique features, which means that sufficiently granular data and forward-looking measurement methodologies are needed to address them.
  • To date, measurement of climate related financial risks has centred on mapping near-term transition risk drivers into bank exposures. Credit risk measurement has attracted the most effort, with a lesser focus on other risk categories. Initial scenario analyses and stress tests have in many cases focused on selected portfolios or exposures for transition risks, and selected hazards for physical risks.
  • Key areas for further analysis relate to gaps in data and risk classification, as well as methodologies to address uncertainties associated with the nature of climate change and the potentially longer time horizon for risks to manifest.

Taken together, the reports conclude that climate risk drivers can be captured in traditional financial risk categories. But additional work is needed to connect climate risk drivers to banks’ exposures and to reliably estimate such risks.

While a range of methodologies is currently in use or being developed, challenges remain in the estimation process, including data gaps and uncertainty associated with the long-term nature and unpredictability of climate change. As these challenges are addressed, the ability to estimate and effectively mitigate climate-related financial risks will improve.

Building on this analytical work, the Committee will investigate the extent to which climate-related financial risks can be addressed within the existing Basel Framework, identify potential gaps in the current framework and consider possible measures to address them. The Committee will undertake further work in three broad strands simultaneously spanning regulatory, supervisory and disclosure-related elements for the banking system.

Climate-related risk drivers and their transmission channels can be downloaded here

Climate-related financial risks – measurement methodologies can be dowloaded here

Source : BIS

Post Author: Wealth Monaco