As climate change continues to pose significant risks to global financial stability, it is imperative for banking sector entities to integrate climate-related vulnerabilities into their risk assessment frameworks. The Financial Stability Board (FSB) has stepped up to this challenge by developing a comprehensive analytical framework and toolkit to assess these climate-related vulnerabilities, focusing on both physical and transition risks.
The FSB’s framework is designed to trace how physical and transition risks are transmitted and amplified within the financial system. It considers a broad range of cross-sectoral and cross-border channels, distinguishing between the effects of climate shocks, their transmission, and amplification. Built on the financial stability surveillance process, the framework focuses on identifying vulnerabilities that may lead to systemic disruptions when triggered by shocks. The framework outlines several transmission channels through which climate risks can impact the financial system:
Credit risk: Arises from concerns about the ability of counterparties affected by climate shocks to meet their obligations.
Market risk: Triggered by abrupt asset repricing as market participants incorporate new expectations related to climate risks.
Liquidity risk: Driven by withdrawal of funding from financial institutions perceived to be overly exposed to climate risks.
Underwriting risk: Faced by insurers due to increased asset damages and deterioration in human health from physical risks.
Other risks: Includes operational losses, legal liability risks, and changes in risk perceptions in financial markets.
The FSB's analytical toolkit comprises three high-level categories of metrics: Proxies, Exposure Metrics, and Risk Metrics. Proxies offer early signals of potential drivers of transition and physical risks, such as trends in absolute emissions, carbon prices, and economic losses from climate hazards. Exposure Metrics provide insights into how climate risk drivers identified by proxies could transmit through the financial system. Risk Metrics quantify the scale of financial impacts as climate shocks interact with vulnerabilities.
Going forward, FSB will continue to develop its framework by operationalizing the toolkit to prioritize further analysis of a subset of metrics and conduct analytical deep dives on specific climate-related vulnerabilities that may have global financial stability implications. The framework and toolkit will be refined further, as understanding of climate-related vulnerabilities evolves and as methodological and data issues are resolved. These efforts will be informed by the work of member authorities and external stakeholders, with the aim of enhancing the resilience of the global financial system to climate risks. By adopting the FSB's framework and toolkit, banks can better understand and manage climate-related vulnerabilities, ensuring a more resilient and stable financial system in the face of growing climate risks.
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