IIF Authors

Status: Will be live at 07/15/2021 07:00

Navigating Climate Headwinds: Reference Approaches for Scenario-based Climate Risk Measurement by Banks and Supervisors

This report takes stock of emerging public sector and banking industry practices on the topic of Scenario-based Climate Risk Measurement (SCRM). The Institute of International Finance (IIF) conducted a stock-taking exercise with 20 large member banks to gather industry experiences on SCRM exercises. 

It is necessary to make a number of design choices when developing an SCRM exercise. A risk of regulatory fragmentation in supervisory exercises is emerging if significantly different approaches are taken. To support greater consistency in supervisory and industry exercises, the IIF has developed a set of “Reference Approaches” as blueprints to guide thinking on the alignment of key design choices with different microprudential, macroprudential, and strategic objectives and applications.

The report sets out proposals to guide greater global alignment, and includes recommendations for prudential authorities on how to move forward:

  • The report discusses the important differences between “climate scenario analysis” and “climate stress testing” are how these differences influence their uses, design and potential applications in a prudential context.
  • The results of medium- or long-term climate scenario analysis exercises should be treated with caution and should not inform capital evaluations, particularly as there are more efficient tools available to incentivize and oversee banks’ management of longer dated risks. 
  • While near-term climate stress testing could conceptually serve as an input to capital adequacy assessment, we believe it would currently not be appropriate to do so as the foundations are not in place with respect to knowledge, data and modelling. 
  • Cross-jurisdictional alignment and collaborative development of SCRM exercises should be a near-term priority for prudential authorities, aided by the global standard setting bodies such as the Basel Committee on Banking Supervision (BCBS).