Financial institutions should be readying themselves for climate-driven stress testing, according to a new report from National Bank Financial Inc. (NBF).
The report, which examines the role of regulators and central bankers in combating the effects of climate change on the financial services industry, indicates that policy-makers around the world, including in Canada, are considering the addition of climate risk factors to their stress-testing procedures.
“Some may mistakenly think the advent of such scenario analysis lies far in the future,” the report says.
In fact, it notes, the Bank of England will start stress-testing British financial institutions in 2021, and the People’s Bank of China is already working on incorporating climate risks into its supervision.
“In the words of the Bank of England governor, such climate-savvy stress tests would improve regulator understanding of risk via three broad oversight channels,” the report notes.
These channels include firms’ management of their specific climate-related risks, examining how individual exposures could add up to a systemic risk, and understanding how the financial system and the economy interact in different climate scenarios.
“Canadian policymakers are also moving on that front,” the NBF report states, noting that the Bank of Canada (BoC) recently released a paper that “unmistakably” signals its intentions; and, that the BoC has joined the Network for Greening the Financial System (NGFS), which is developing macrofinancial scenarios.
“So yes – it’s coming, and many financial institutions could be caught off guard,” NBF says.
While some banks have started evaluating their physical and transition risks, the NBF report concludes, “many banks are still in the dark, lacking both relevant data and expertise.”