On 14 April 2021, the Basel Committee on Banking Supervision (Basel Committee) published a report ‘Climate-related risk drivers and their transmission channels’.
The report explores how climate-related financial risks can arise and impact both banks and the banking system. By synthesising existing literature, it illustrates how physical and transition climate risk drivers affect banks’ financial risks via micro- and macroeconomic transmission channels. It also explores various factors that may determine the likelihood or size of the impact from climate-related risk drivers.
The report’s main findings are as follows:
- Banks and the banking system are exposed to climate change through macro- and microeconomic transmission channels that arise from two distinct types of climate risk drivers.
- Evidence suggests that the impacts of these risk drivers on banks can be observed through traditional risk categories.
- Existing literature largely focuses on the impacts of climate risk drivers on those aspects of the economy relevant to banks’ credit risk, and to a lesser extent on market risk.
- Climate-related events and risks are uncertain, and may be subject to non-linearities.
- To size climate-related financial risks, banks and regulators require plausible ranges of scenarios to assess the potential impacts of both physical and transition risk drivers on their exposures.
- There is a limited amount of research and accompanying data that explore how climate risk drivers feed into transmission channels and the financial risks faced by banks.
The report also highlights how the economic and financial market impacts of physical and transition risks can vary according to geography, by sector and by economic and financial system development. For example banks’ business models and exposures can increase the severity of any climate-related risk impact. This is because certain economic sectors will have greater sensitivities to acute climate related physical risks or to the transition to a low-carbon economy.
The report concludes that traditional risk categories used by financial institutions and reflected in the Basel framework can be used to capture climate-related financial risks. To explore this further, a comprehensive analysis could usefully be undertaken on how climate-related financial risks can be incorporated into the existing Basel framework.
The Basel Committee has also published a report that provides an overview of conceptual issues related to climate-related financial risk measurement and methodologies, as well as practical implementation by banks and banking supervisors.