Deputy Governor Christian Hawkesby says each year we run stress tests to assess banks’ resilience, making sure they have enough capital to withstand severe shocks, while being able to continue supporting the economy. In the case of the climate stress test, the main purpose is to improve banks’ capability to manage climate-related risks.
“Climate change is already impacting the global economy and the risks are expected to intensify. The severe weather events in the North Island this year are examples of climate change playing out locally. Globally we are seeing the extreme climate crises other countries are dealing with,” Mr Hawkesby says.
“As kaitiaki of Aotearoa’s financial system, we have a role to play in helping the financial industry prepare for the growing physical and transition risks that climate change poses, and that’s what this stress test scenario aims to do."
“We appreciate banks’ willingness to participate in the climate stress test and look forward to collectively building our understanding of how climate risks may playout in the banking sector and building the capability to manage those risks.”
The 2023 scenario, titled ‘Too Little, Too Late’ was developed in consultation with the participating banks – ANZ, ASB, BNZ, KiwiBank and Westpac - and climate experts. It is based on core components of scenarios developed by the Network for Greening the Financial System, plus New Zealand specific elements. Banks have until the end of this year to determine their exposure to climate-related risks by modelling the effects of the scenario on their balance sheets out to 2050. We will publish an aggregate report on how the banks performed early next year.
While work by participating banks is progressing, non-participating banks and other financial institutions may find the scenario helpful as they consider and develop their own responses to climate risks.
Stress testing assesses the resilience of banks and insurers to severe but plausible risks, including economic downturns. The results of stress tests help us monitor financial stability and our policy decisions and also help entities manage risk and set capital and liquidity buffers.
We use annual stress tests to look at the 3 main financial sectors we regulate – Banking, General Insurance and Life Insurance. The outputs from stress tests can be used by regulators to assess risks to individual entities and the broader financial system, and to inform policy decisions. Entities can use stress tests for risk management, capital and liquidity buffer setting, and strategy and investment decisions.
The design of this climate scenario began in the second half of 2022. It has been developed in collaboration with participating banks. We have also consulted widely across the Reserve Bank, with experts from industry, academia and government, and with fellow regulators who have conducted similar exercises including APRA, the Bank of England, and the European Central Bank.
For some of the detailed variable paths we have taken guidance from scenarios developed by the Network for Greening the Financial System (NGFS). The NGFS scenarios have been subject to rigorous testing and input from the scientific and economic community.
This scenario is somewhat unique in that it combines the impacts from 2 of the NGFS scenarios - Current Policies and Delayed Transition.
Banks are due to submit their final results by the end of the year. We plan to release aggregate results in early 2024.
While this scenario was designed to be severe, including a combination of plausible physical and transition climate-related risks, it is only one hypothetical scenario among many possible ways that climate-related risks could play out in the coming decades. Scenarios are not intended to be used as a predictive tool, their purpose is to explore how risks might plausibly evolve.
Climate change poses a range of risks to the financial system. These risks are typically characterised as physical or transition related. Physical risks can be driven by an increased severity and frequency of natural disasters (acute risk) and by gradual changes in climate patterns, such as higher temperatures (chronic risk). Transition risks result from the adjustment of societies and economies to lower emissions through, for example, emissions pricing, new technology and innovation, litigation, and changes in consumer preferences.
No. The 2023 Climate Stress Test builds on previous stress testing of climate-related risks: the 2021 Bank solvency stress test which included drought as part of the scenario; the 2021 General Insurance stress test which included a series of severe storm events; and the 2022 risk assessment of bank’s residential mortgages to flooding and agricultural lending to drought and emissions pricing.