Bocconi Students for Sustainable Finance

BANKING REGULATORS START CLIMATE STRESS TESTS

“Climate change has the potential to cause substantial disruption to our economies, businesses and livelihoods in the coming decades. Yet the associated risks remain poorly understood, as climate shocks differ from the financial shocks observed during previous crises.”

That is the opening of the latest month’s blog post by Luis de Guindos, Vice President of the ECB. Central banks play a crucial role in the macroeconomic scenario. Not only do they set the rules to play in the “Banking & Finance” segment, reaching the stability goal, but also, they are the supervisors, i.e., they check whether and how these rules are followed by any players. Talking about vigilance means talking about risks. Maybe some of us could have heard along their professional and academic way about the Basel Accords, which have set the rules focusing on the main risks that this kind of activity may encounter.

The so-called stress tests are the place meant to assess these kinds of risks. But times are changing, businesses are evolving, as well as stakeholders’ priorities in valuating such processes. As Sarah Breeden, an executive director at the Bank of England, has stated: “Climate change, not the coronavirus pandemic, is the defining issue of our time.” We are witnessing such a turning point in the way of conducting business; therefore, among all players, banking needs to move toward this direction, by monitoring such a risk, and the arising consequences in terms of vulnerability to the effects of climate change.

What kind of risks are we talking about? As in the abovementioned post by Luis de Guindos, climate change risk can be split into two broad categories: firstly, physical risk, regarding the magnitude of disasters caused by natural hazards, and the arising consequences for those businesses located in more “exposed” areas. Secondly, transition risks, related to a general change towards a carbon-free economy in order to reduce the environmental footprint, and the stemming risks in terms of profitability of carbon-intensive industries.

Now imagine a bank that incorporates among its assets suck risks. It would be nonsense for regulators and supervisors to neglect this key point while assessing the financial stability of these players, to maintain trust in the whole economy. That is why lately, some regulators have researched “climate-related financial risk”, to get a wider understanding of the general situation in the market, regarding how the business models could be affected or harmed, and how to mitigate such prominent risks. These tests are to “assess banks’ resilience in certain scenarios […], and make them start taking measures to adapt”, claimed Patrick Amis, director-general at the ECB.

The role of central banks in economics is to release signals and to set targets, to guide markets and the whole economy towards trust and stability. Those are the reasons why the ECB has decided to release the first economy-wide climate stress tests by July, remarking the importance of environmental risks in conducting business, a clear signal that states “out loud” that these are not just empty words. Anybody has to play their own world to embrace this ongoing challenge to find a new better way for a better future.

 

SOURCES:

 

Author: Enrico Grassi

RELATED

BANKING REGULATORS START CLIMATE STRESS TESTS

“Climate change has the potential to cause substantial disruption to our economies, businesses and livelihoods in the coming decades. Yet the associated risks remain poorly understood, as climate shocks differ from the financial shocks observed during previous crises.”

That is the opening of the latest month’s blog post by Luis de Guindos, Vice President of the ECB. Central banks play a crucial role in the macroeconomic scenario. Not only do they set the rules to play in the “Banking & Finance” segment, reaching the stability goal, but also, they are the supervisors, i.e., they check whether and how these rules are followed by any players. Talking about vigilance means talking about risks. Maybe some of us could have heard along their professional and academic way about the Basel Accords, which have set the rules focusing on the main risks that this kind of activity may encounter.

The so-called stress tests are the place meant to assess these kinds of risks. But times are changing, businesses are evolving, as well as stakeholders’ priorities in valuating such processes. As Sarah Breeden, an executive director at the Bank of England, has stated: “Climate change, not the coronavirus pandemic, is the defining issue of our time.” We are witnessing such a turning point in the way of conducting business; therefore, among all players, banking needs to move toward this direction, by monitoring such a risk, and the arising consequences in terms of vulnerability to the effects of climate change.

What kind of risks are we talking about? As in the abovementioned post by Luis de Guindos, climate change risk can be split into two broad categories: firstly, physical risk, regarding the magnitude of disasters caused by natural hazards, and the arising consequences for those businesses located in more “exposed” areas. Secondly, transition risks, related to a general change towards a carbon-free economy in order to reduce the environmental footprint, and the stemming risks in terms of profitability of carbon-intensive industries.

Now imagine a bank that incorporates among its assets suck risks. It would be nonsense for regulators and supervisors to neglect this key point while assessing the financial stability of these players, to maintain trust in the whole economy. That is why lately, some regulators have researched “climate-related financial risk”, to get a wider understanding of the general situation in the market, regarding how the business models could be affected or harmed, and how to mitigate such prominent risks. These tests are to “assess banks’ resilience in certain scenarios […], and make them start taking measures to adapt”, claimed Patrick Amis, director-general at the ECB.

The role of central banks in economics is to release signals and to set targets, to guide markets and the whole economy towards trust and stability. Those are the reasons why the ECB has decided to release the first economy-wide climate stress tests by July, remarking the importance of environmental risks in conducting business, a clear signal that states “out loud” that these are not just empty words. Anybody has to play their own world to embrace this ongoing challenge to find a new better way for a better future.

 

SOURCES:

Author: Enrico Grassi

RELATED