The Basel Committee on Banking Supervision (BCBS) has published its long-awaited principles on the effective management and supervision of climate-related financial risks, after confirmation that it had approved a final list of principles in May.
The news comes more than a year after the BCBS had announced the establishment of a high-level Task Force on Climate-related Financial Risks (TFCR) and aims to bring additional regulatory control over the banking sector’s understanding and assessment of climate change as a financial risk.
Assessment, management and supervision
Unofficially referred to as Basel V, the 18 principles cover corporate governance, internal controls, risk assessment, management and reporting.
There are 12 principles on climate risk management for banks; the other six provide guidance to prudential supervisors.
For the banking sector, the principles point to necessary assignment of climate-related responsibilities to board committee members, the definition of climate-related responsibilities across credit reviews, risk assessment and internal audit divisions, and the inclusion of climate-related material risks assessments within internal capital and liquidity adequacy processes.
Banks should continuously develop their capabilities and expertise on climate-related financial risks commensurate with the risks they face
On the supervisory side, Basel V suggests that supervisors should conduct regular and cross-border assessments, including stress testing, to verify the operational resilience of banks’ risk-management models.
A distinction is made between stress testing and climate-scenario analysis as two separate supervisory tools to assess banks’ resilience to climate risk.
This further points to the difficulties of assessing climate risk exposure and impact according to various timeframes, considering the build-up of systemic risk due to the irreversible impacts of climate change.
The responsibility of risk management, which falls on the regulators and the banking sector, has to account for the uncertainties around forecasts on market mechanisms’ impact, along with how long-dated exposures will translate into material risk.
Addressing the data gap
Principle 7 addresses a contentious point in the debate over regulatory frameworks: data availability and analysis.
The report says that banks should have systems in place to collect and aggregate climate-related financial risk data as an integral part of data governance and IT infrastructure, and consider investing additional resources to improve systems where necessary.
In addition, the BCBS also points to the use of scenario analysis as a means for banks to “diagnose data and methodological limitations in climate risk management” (principle 12), and for supervisors to facilitate information-sharing and identify common data and methodological gaps (principle 18).
Room for improvement
The BCBS is careful not to define climate risk as a fixed notion and to make room for new developments in supervisory exercises and risk-management best practices.
“It is recognised that the management of climate-related financial risks, and the methodologies and data used to analyse these risks, are currently evolving and are expected to mature over time,” the report states.
“Banks should therefore continuously develop their capabilities and expertise on climate-related financial risks commensurate with the risks they face and ensure they have appropriate resources allocated to managing these risks.”
It is still unclear whether additional capital requirements will follow. The principles fall only under Basel’s Pillar 2 approach, dealing with risk-management best practices and supervisory assessments.
Pillar 1 and 3 of the Basel framework, which look at capital requirements and market discipline respectively, are expected to come at a later point.
The principles do not explicitly say when different jurisdictions will have to integrate these principles into their respective supervisory frameworks and banking systems, although the BCBS will be monitoring this implementation.
