BIS: The Role of Climate Scenario Analysis in Strengthening the Management and Supervision of Climate-Related Financial Risks

? The Basel Committee on Banking Supervision has issued a discussion paper on how climate scenario analysis (CSA) can be practically used to help strengthen the management and supervision of climate-related financial risks. CSA is pivotal in assisting banks and supervisors to evaluate and strengthen business model resilience and risk management strategies against various plausible climate-related pathways.

? The paper outlines four primary objectives of CSA within the Basel Framework:

1. Risk Identification: CSA assists in identifying specific exposures vulnerable to climate risk drivers, utilizing feedback loops to study compound risks and multiple simultaneous shocks.
2. Risk Management Processes: It evaluates potential losses across a range of severe climate scenarios, influences pricing, and determines exposure limits, thereby enhancing risk monitoring and control.
3. Internal and Supervisory Capital and Liquidity Assessments: CSA supports banks in ensuring that their internal capital and liquidity assessments reflect climate-related financial risks accurately.
4. Assessment of Business Model Resilience and Business Strategy Building: CSA informs strategic planning by projecting the long-term impacts of structural changes due to climate change and economic transition towards a low-carbon environment.

? The discussion paper emphasizes that CSA should be comprehensive, plausible, coherent, transparent, tractable and proportional to the materiality of the risks assessed. It also highlights the challenges of integrating CSA into standard banking operations due to data availability, methodological uncertainties and the evolving nature of climate science.

Original source: The role of climate scenario analysis in strengthening the management and supervision of climate-related financial risks (bis.org)