The regulatory response to climate risks: some challenges

Highlights

• There is a need for authorities to review their prudential frameworks with a view to taking full account of the implications of climate-related financial risks for financial stability.
• Given the longer time horizons and the higher degree of uncertainty associated with the materialisation of climate-related financial risks, standard Pillar 1 instruments might be suboptimal in addressing such risks.
• In contrast, the intrinsic flexibility of the Pillar 2 framework makes it the natural candidate for ensuring that banks effectively manage such risks and have sufficient loss-absorbing capacity against them.
• Applying the current macroprudential framework to contain systemic climate-related financial risks is likely to be ineffective and potentially counterproductive for financial stability. The same could be said of the introduction of a green supporting factor.