G20 watchdog says bank climate stress tests may understate exposures

LONDON  – Climate-related stress tests for banks need to better capture the indirect fallout of climate change on lenders and the wider global economy, the G20’s Financial Stability Board said on Tuesday.

The European Central Bank, Bank of England and other central banks have completed an initial batch of experimental stress tests to assess how banks will cope with the impact of climate change on their business.

The results were not used to determine capital levels.

The FSB said in a joint report with the Network for Greening the Financial System, a grouping of central banks whose work shaped the initial climate test scenarios, that initial exercises were limited to the domestic impact.

“In addition, measures of exposure and vulnerability are likely understated,” the report said.

Echoing what industry officials have already said, the report said that many of the tests do not capture ‘second round’ effects, or impact on banks of climate change hitting the wider economy.

The tests also did not fully capture potentially large sources of risk, such as those from an abrupt correction in the prices of assets on bank balance sheets.

Data gaps need plugging and more cross-border action was also needed, the report added.

“A key priority going forward will be to enhance the understanding of how first-round and second-round effects under different scenarios could give rise to financial stability concerns,” Klaas Knot, chair of the FSB and the Dutch central bank, said in a statement.

Earlier this month the European Central Bank said euro zone lenders were still failing to meet its climate disclosure and management expectations.

The Bank of England said in July that future climate-related stress tests could focus on specific activities at banks, such as trading, which was missing from its first test.