Initially a hallmark of progressive central bankers, stress testing for climate-related risks at banks and insurers is set to become an increasingly mainstream activity over the next couple of years, said Fitch Ratings in a new report.
The rating agency said the phenomenon of regulatory stress testing for environmental risks that has begun in Europe and the U.K. is starting to expand to other jurisdictions.
“As supervisors become increasingly aware of the urgency in gauging the risks from climate change,” banks and insurers around the world will likely face climate-related stress tests in the next two to three years, Fitch said.
The first-ever stress testing results for climate risks are due to be released by French financial institutions in April, followed by the U.K.’s biennial stress testing in June, Fitch said.
“The European Central Bank will test significant eurozone banks in 2022,” it added.
Additionally, regulators in Australia, Brazil, Canada, Hong Kong and Singapore have all planned tests for 2021 and 2022, Fitch said.
And, while climate stress testing of financial institutions has not been announced in China or Japan, Fitch said that it believes measures are “coming soon.”
In the U.S., climate considerations are expected to become more significant for financial institutions, “as climate change is a priority for the U.S. government under the Biden administration,” the report noted.
While these initial stress tests will not assess capital adequacy, Fitch said that the tests “may lead companies to look more closely at whether they need to hold more capital to cover potential losses from climate-change risks.”
Ultimately, the rating agency expects that these exercises will have capital implications, too.
“In the longer term, we expect climate stress tests to feed into prudential capital requirements,” the Fitch report said.
Plus, the effects will eventually filter down to various sectors of the economy.
“More banks and insurers are likely to start shifting their balance sheets away from some of the sectors most exposed to climate-change risks, such as manufacturing, electricity, construction, transport and real estate,” Fitch said.