Capturing Risk Differentials from Climate-related Risks

May 30, 2022Published by Network for Greening the Financial System

This Network for Greening the Financial System report examines the case for overhauling central banks’ capital requirements and buffers based on climate considerations.

It argues that although there is increasing interest from supervisors in adjusting requirements based on the “greenness” of particular assets and activities, this would require sufficient evidence showing that an assets’ climate impact materially affects its credit risk – something which the authors say is not yet demonstrated by the available evidence.

However, this is mainly due to the lack of relevant data rather than significant findings to the contrary. Indeed, the paper highlights some studies suggesting such a link, including a European Central Bank working paper that suggests more polluting firms may be subject to greater cash flow volatility and uncertainty in returns on assets.

Central banks could also choose to adjust institutions’ capital requirements and buffers based on forward-looking tools such as climate scenario analysis and scrutiny of transition plans, say the authors.

The report also examines methodologies from credit ratings agencies for attempting to quantify the impact of climate-related credit factors. It outlines a series of difficulties they face, such as the fact that climate risk at the activity or asset level does not directly translate to a similar level of risk for the firm itself.

This page was last updated May 30, 2022

Share this article