Principles for the effective management and supervision of climate-related financial risks

General Information

The document "Principles for the effective management and supervision of climate-related financial risks" was published in June 2022 by the Basel Committee on Banking Supervision (BCBS). It is a 15-page standard aimed at providing guiding principles for the effective management and supervision of climate-related financial risks in the banking sector. The scope covers physical and transition risks related to climate change, their impact on banks, and regulatory and supervisory practices at the international level, focusing on international banks and their supervisors, while remaining proportionately applicable to other banks.

Executive Summary

This document addresses the management and supervision of financial risks related to climate change, which may threaten banks' soundness and overall financial stability (p. 1). These risks include physical risks (damage related to climate events) and transition risks (economic changes linked to the transition to a low-carbon economy). The BCBS established a dedicated working group in 2020 to analyze these risks and integrate their specificities into the banking regulatory framework. The document presents 18 principles: 12 for banks on climate risk management, and 6 for supervisors on their role and methods (p. 5-6). The principles emphasize integrating climate risks into governance, internal control, traditional risk management (credit, market, liquidity, operational), capital and liquidity, as well as using scenario analyses covering different time horizons (p. 7-12). For supervisors, the task is to verify that banks integrate these risks into their strategy, governance, and management, assess their risk identification and control capabilities, and use tools such as climate stress testing to evaluate banks' resilience (p. 12-15). The document recommends a proportionate approach according to banks' size and complexity, encourages international collaboration, and highlights that practices and methodologies will evolve with scientific and technical advances (p. 6, 14). These principles aim to harmonize international expectations while allowing flexibility adapted to local contexts.

Context and Objectives

Climate change generates new and complex financial risks for banks, potentially affecting their solvency and the stability of the global banking system (p. 1). In response, the BCBS launched a working group in 2020 to analyze these risks, assess existing regulatory initiatives, and identify gaps in the current regulatory framework (p. 1). The objective is to provide guiding principles to help banks and supervisors better manage these risks, relying on fundamental banking supervision principles and considering the diversity of banking systems and evolving practices (p. 1-2). The document aims to promote a principles-based approach, proportionately applicable according to the size and complexity of institutions, and to encourage better international harmonization of practices (p. 2). It does not prescribe specific rules but proposes a flexible framework to support the evolution of methodologies and data on climate risks.

Summary of Key Points by Theme

Corporate Governance: Banks must integrate climate risks into their strategy and governance, with clear involvement of the board of directors and senior management. Responsibilities must be explicitly assigned, skills strengthened, and internal policies adapted to manage these risks (principles 1 to 3, p. 6-7).

Internal Control: Climate risks must be integrated into the internal control framework according to the three lines of defense, with clearly defined responsibilities, independent oversight by the risk function, and internal audit ensuring control quality (principle 4, p. 7-8).

Capital and Liquidity: Banks must identify and quantify material climate risks and integrate them into their internal capital adequacy and liquidity assessment processes, including through stress tests adapted to physical and transition risks (principle 5, p. 8-9).

Risk Management: All traditional financial risks (credit, market, liquidity, operational) must incorporate climate risk impacts. Banks must define their appetite for these risks, implement key indicators, and consider appropriate mitigation measures (principles 6 to 11, p. 9-12).

Scenario Analysis: Banks must use climate scenario analyses to test the resilience of their business models and strategies over short and long horizons, considering uncertainties and regularly reviewing their methodologies (principle 12, p. 11-12).

Supervision: Supervisors must ensure that banks properly integrate climate risks into governance, risk management, and internal controls, and that they have adequate capabilities for identification, measurement, and management of these risks. They must use tools such as climate stress testing, collaborate internationally, and have the necessary resources and skills (principles 13 to 18, p. 12-15).

Main Findings and Lessons Learned

Findings: Climate change generates physical and transition financial risks likely to affect banks' soundness and financial stability (p. 1). Current regulatory frameworks are flexible but require specific guidance to address these risks (p. 1-2). Banks must integrate these risks into governance, risk management, capital, and liquidity, with appropriate monitoring (p. 6-12). Supervisors must assess these integrations and use adapted supervisory tools (p. 12-15).

Assumptions: Climate risks may materialize over long horizons, sometimes beyond traditional capital plans (p. 6-7). Methodologies and data for analyzing these risks are evolving and must be progressively improved (p. 6, 8-9, 11).

Interpretations: A proportionate approach based on banks' size and complexity is necessary (p. 6). Scenario analysis is a key tool to anticipate impacts and test resilience (p. 11-12). International collaboration is essential to harmonize practices and optimize resources (p. 13-15).

Uncertainties: Uncertainties related to time horizons, data, and climate models make risk management complex and evolving (p. 6, 11, 14). Communication of results must consider these limitations (p. 14).

Conclusions and Recommendations

The BCBS recommends systematic and proportionate integration of climate risks into governance, risk management, internal controls, and banks' capital adequacy and liquidity processes (p. 5-12). It emphasizes the importance of climate scenario analysis to assess banks' resilience over different horizons (p. 11-12). Supervisors must strengthen their capacities to assess these risks, use appropriate tools such as climate stress testing, and collaborate internationally to share best practices and coordinate supervisory exercises (p. 12-15). The document encourages a flexible, evolving approach adapted to the diversity of banks and jurisdictions, considering future scientific and methodological advances (p. 6, 14-15).