The Australian Prudential Regulation Authority (APRA) warns that climate change may pose future financial challenges for both banks and their borrowers, according to recent findings.
Conducted over the past two years, APRA undertook its inaugural Climate Vulnerability Assessment (CVA) on behalf of the Council of Financial Regulators (CFR) to assess the potential financial impacts of climate change in the future.
The CVA was based on modelling by ANZ, Commonwealth Bank, Macquarie Bank, National Australia Bank and Westpac that estimated impacts on their businesses, in addition to how they might respond to consequent physical and transition risks.
APRA deputy chair Helen Rowell noted that the findings “provide valuable insights into how climate change may test the resilience of the banking system over the coming years and decades and how banks might react to manage those impacts”.
“The results suggest that banks’ losses from their lending portfolios could rise in the medium to long term as climate change and the global response to it unfolds.”
While APRA doesn’t expect these impacts to cause severe stress to the banking system, Ms Rowell asserted that climate change could lead the banking sector to become more vulnerable to future economic downturns.
Participating banks adopted two internationally recognised climate scenarios developed by the Network for Greening the Financial System: one explored a future with a rapid reduction in global emissions from 2030, while the other represented a future with a continued increase in global emissions into 2050 and beyond.
According to the CVA results, climate risk impacts are likely to be concentrated in specific regions and industries.
APRA found that mortgage lending losses were higher in northern Australia, while bank losses were higher from lending to business sectors that are more exposed to transition risks, such as mining, manufacturing and transport.
Moreover, the banks predicted that they would adjust their risk appetites and lending practices in response to these potential losses, such as cutting back on high loan-to-valuation lending and reducing their exposure to higher-risk regions and industries.
Ms Rowell said the modelling exercise had proved valuable for both APRA and the participating banks.
“Despite the high profile of climate change, climate risk management and modelling remain emerging areas of expertise, in part due to uncertainty about how the risks will play out decades into the future, and how these risks are incorporated into financial models,” she explained.
“By undertaking this exercise, participating banks have needed to develop new tools, techniques and data sources related to climate risk analysis. Differences in the modelling approaches and assumptions used by the banks, which produced a wide variation in results, also point to areas where further exploration and development is needed.”
Ms Rowell commented that the CVA’s results are a “good start” and consequently urged “all APRA-regulated entities to examine the CVA findings to see how they can leverage the insights to enhance their own climate risk analysis and management”.
