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2023 Climate Stress Test results

We use stress testing to assess the resilience of banks and insurers to severe but plausible risks. This Bulletin looks at our 2023 Climate Stress Test results for banks.

Jonathon Adams-Kane, Ken Nicholls, Tom West

2023 Climate Stress Test results
2023 Climate Stress Test results

We use stress testing to assess the resilience of banks and insurers to severe but plausible risks. This Bulletin looks at our 2023 Climate Stress Test results for banks.

Objectives of the 2023 Climate Stress Test


The Climate Stress Test was the main bank stress test for 2023.

The Climate Stress Test had 2 main objectives.

  1. To assess the financial impacts of a scenario involving climate-related risks on our largest banks’ balance sheets.
  2. To uplift industry capability in managing such risks.

We thank ANZ Bank New Zealand, ASB Bank, Bank of New Zealand, Kiwibank, and Westpac New Zealand for their participation and collaborative approach. These banks make up approximately 90% of total bank lending in Aotearoa New Zealand. 

The 2023 Climate Stress Test scenario


We designed a scenario called 'Too Little Too Late'. Our scenario combines high physical risks from climate change, such as flood and drought, with high transition risks (risks that may materialise through global and domestic efforts to decarbonise the economy).

The scenario covers the period 2023 to 2050, a much longer time frame than our previous stress tests (3 to 5 years). This reflects the longer-term nature of how the transition risks develop and interact with physical risks, compared to a short, sharp economic shock that has featured in past stress tests.

We designed the scenario with participating banks, New Zealand climate experts, and fellow regulators. The 'Too Little Too Late' scenario represents only one way New Zealand's climate scenario could play out. It is not a prediction but one of many scenarios that entities should explore when testing for climate-related risks.

Financial impact of the 2023 Climate Stress Test scenario


Banks used their models to estimate the scenario's effect on their balance sheets, profits, dividends, and capital.

Bank illustration

Key findings

  • The Too Little Too Late scenario alone did not threaten bank solvency or financial stability, with banks able to maintain their capital ratios.
  • It did come at a significant cost to shareholders, with modelled dividends nearly 40% lower and profits 25% lower than in a base case scenario absent climate risks. Aggregate impairment expenses were 5 times the base case.
  • The impact on banks' financial positions means they would be less financially resilient to other shocks, such as a severe economic recession, which could occur within the scenario's multi-decade timespan.
  • Banks identified strategic actions they could take that may lessen the financial impact and assist customers transition to a lower carbon emitting economy.

Capability improvements


Banks commented that while the exercise was resource intensive, it paid off by significantly improving capability and identifying areas of climate-related risks that need to be managed.

These benefits include:

  • improvements in modelling
  • sourcing climate-relevant data
  • informing insurance retreat impacts
  • embedding climate expertise across the organisation, and
  • identifying strategic actions to mitigate the risks.

Recommendations


Despite the capability improvements, there is more work to be done. To assist, our Bulletin contains recommendations for banks that emerged from this exercise to improve managing climate-related risks.

Some of the recommendations include:

  • addressing significant remaining data gaps
  • continuing the development of credit risk modelling using climate-risk variables, and
  • considering cost-effective ways of tracking the insurance status of mortgages.