Director of Financial Stability Assessment & Strategy Kerry Watt says each year we run stress tests to assess banks' resilience. The key stress-test for New Zealand's five largest banks in 2023 featured a scenario called 'Too Little Too Late' that tested their ability to withstand severe but plausible long-term climate-related challenges.
"We deliberately designed the climate stress test scenario to be challenging. It included high physical and transition risks over a prolonged period of 28 years. Our aim was to assess the financial impact of the scenario on the banks' balance sheets and uplift their capability in managing climate related risks," Mr Watt says.
"The results show that the Too Little Too Late' scenario did not threaten bank solvency, as all banks were able to maintain their capital ratios. However, it did highlight that climate-related risks have the potential to significantly reduce bank profitability, raise risk-weighted assets and reduce shareholders' returns over the medium to long term. This tells us that climate related risks need to be actively managed to protect the resilience of the system to other shocks.
"The stress test also improved banks' capability in managing climate-related risks in several areas. These include modelling, sourcing of climate relevant data, informing insurance retreat impacts, embedding climate expertise widely across the organisation and identifying strategic actions to mitigate the risks."
We have released a number of recommendations with our findings that include banks 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. We expect all banks to reflect on these recommendations and are considering how we might support banks that did not participate in this stress test to incorporate them into their risk monitoring and management activity.
"It's important to recognise the Too Little Too Late scenario represents only one way New Zealand's climate scenario could play out. Banks will consider others as part of their own internal risk management and to feed into mandatory climate-related disclosures. We would like to express our thanks to the banks that participated."
The Reserve Bank will continue to play an active role in monitoring this work undertaken by entities as they draw on the learnings from our stress testing activities, our guidance on managing climate-related risks, and related supervisory discussions.
