The Basel Committee's initiatives on climate-related financial risks

Mr Kevin J Stiroh, co-chair of the Task Force on Climate-related Financial Risks of the Basel Committee on Banking Supervision and Executive Vice President of the Federal Reserve Bank of New York, at the panel session on "New regulatory and policy landscape for sustainable finance", 2020 IIF Annual Membership Meeting, 14 October 2020.

Thank you for the invitation to participate in the 2020 IIF Annual Membership Meeting. I am pleased to share my perspective regarding the current regulatory and policy initiatives in the area of sustainable finance. My remarks are being made in my capacity as co-chair of the Task Force on Climate-related Financial Risks (TFCR), which is part of the work of the Basel Committee on Banking Supervision. I should note that my prepared remarks and subsequent comments made as part of the panel discussion may not necessarily reflect the views of the Basel Committee or its members, or those of the Federal Reserve System or the Federal Reserve Bank of New York.

The Basel Committee's mandate is to strengthen the regulation, supervision and practices of banks worldwide with the purpose of enhancing financial stability. It is the primary global standard setter for the prudential regulation of banks and provides a forum for cooperation on banking supervisory matters. As part of its work, the Committee exchanges information on developments in the banking sector and financial markets to help identify current or emerging risks for the global financial system.

The Committee noted that climate change may result in physical and transition risks that could potentially impact the safety and soundness of individual financial institutions and have broader financial stability implications for the banking system.

In February 2020, the Basel Committee established the TFCR to undertake work on climate-related financial risks. I am acting as a co-chair of the task force, along with Frank Elderson, Executive Director of Supervision at the Netherlands Bank.  

In the first phase of work, the TFCR conducted a stocktake of members' existing regulatory and supervisory initiatives on climate-related financial risks. The results of the stocktake were published in April 2020. I am pleased to share some of the key findings from that work.

All respondents noted that climate change may result in risks that could potentially have financial stability implications for the banking system. The majority of authorities considered it appropriate to address climate-related financial risks within their existing regulatory and supervisory framework. In addition, a large majority of members have conducted research related to the measurement of climate-related financial risks. At the same time, respondents identified a number of operational challenges in developing a robust framework to assess risks, including data gaps, methodological challenges and difficulties in mapping the transmission of climate risks to the banking system. The report also noted that a majority of authorities have taken measures to raise awareness of climate-related financial risks among banks. Approximately two fifths of members have issued, or are in the process of issuing, more principles-based guidance regarding climate-related financial risks. However, it is important to note that the majority of members have not factored, or have not yet considered factoring, the mitigation of such risks into the prudential capital framework.

The stocktake was conducted before the pandemic. After the Covid-19 outbreak, we understood that members needed to focus resources on addressing immediate financial stability priorities related to the pandemic. At the same time, Covid-19 further highlighted the importance of mitigating the risks of events with potentially severe global impacts. The Basel Committee is therefore continuing its work in this area.

To take the work forward, the TFCR is following a gradual and sequential approach from a banking supervisory perspective, with a current focus on understanding climate risk transmission channels as well as methodologies for measuring and assessing these risks. The TFCR plans to complete these fundamental research initiatives by mid-2021.

Building on this analytical work, the TFCR will consider the extent to which climate-related financial risks are incorporated in the existing Basel Framework, and identify effective supervisory practices to mitigate such risks. The TFCR does not currently have a view on potential prudential treatments or supervisory expectations related to the mitigation of climate-related financial risks.

As we are discussing today, there is a multitude of initiatives under way among a wide range of international forums, central banks, academics and private sector stakeholders to study climate-related financial risks, and coordination at the global level would be beneficial. The TFCR is actively monitoring related initiatives in order to leverage such work and facilitate information-sharing across parallel initiatives to the extent possible. The Basel Committee is an observer on the Network for Greening the Financial System (NGFS), which is chaired by Frank Elderson, my co-chair on the TFCR. This allows the two bodies to coordinate and ensure synergies wherever possible. The Committee also engages with the Financial Stability Board and other international standard-setting bodies to share information and contribute to global coordination in the area of climate-related financial risks.

In order to inform our work, the TFCR is also engaging directly with the private sector. Over the past two days, the TFCR held two industry outreach events with internationally active banks to learn about practices in the banking sector. This dialogue was informative and productive. We learned that banks are attempting to gauge the financial risks arising from climate change, and are trying to integrate oversight of these risks into their overall risk management framework. There are many different instruments and measurement methodologies being considered, including scenario analysis, stress testing and heat maps. As many methodologies are still at an early stage of development, and some might be idiosyncratic and adapted to certain business models, collective efforts will be needed to bridge the knowledge gap and inspire consistent and comparable efforts among stakeholders and jurisdictions.

I am encouraged that the financial sector recognises the value of coordinated efforts, including through this year's IIF Annual Membership Meeting, which provides us a great opportunity to tackle ESG issues together, exchange information and share knowledge among different stakeholders. The TFCR and the Basel Committee are committed to being part of this important global conversation going forward.