Australian regulator releases guidance on managing the financial risks of climate change

The Australian Prudential Regulation Authority (APRA) has outlined details of a major new exercise testing the possible exposure of its five largest banks to climate risk.

According to the ARPA, the Climate Vulnerability Assessment (CVA) will provide insights into the potential financial exposure of institutions, the financial system and economy to the physical and transition risks of climate change.

The CVA will measure the impact on individual institutions and the financial system of two different plausible future scenarios for how climate change, and the global response to it, may unfold.

Along with its draft prudential guidance on climate risk, which closed for consultation on 31 July 2021, the CVA forms a core plank of APRA’s efforts to help its regulated entities understand and manage the financial risks associated with climate change.

Australia’s five largest banks participating in the CVA are ANZ; Commonwealth Bank; Macquarie Bank; National Australia Bank; and Westpac.

The banks commenced their CVAs in June, and are due to submit their first CVA analysis towards the end of this year, with publication of aggregated results and findings expected early next year.

APRA chair Wayne Byres said: “APRA began the CVA program in the banking sector due to its centrality to the Australian financial system, as well as the potential impacts associated with climate risk across the portfolios, from household mortgages to business exposures”.

“The results should help the boards and management of participating institutions to understand and proactively address any identified risks, as well as capitalise on new opportunities. They will also help regulators with a better picture of the nature of the risks, and how financial institutions plan to respond.”

The inaugural CVA was designed in consultation with the participating banks and the Australian Banking Association, as well as other agencies on the Council of Financial Regulators.

It uses two future climate scenarios published by the international Network for Greening the Financial System, which were tailored to Australian conditions:

a scenario exploring higher transition risks due to delayed or divergent emissions reduction pathways across countries and sectors.

a scenario that assumes limited further action on climate change globally, with efforts insufficient to avoid significant global warming, resulting in more severe physical risks.

The information paper also compares and contrasts the CVA with similar assessments that other central banks and regulators, including the European Central Bank, the Bank of England and Banque de France, are undertaking in their jurisdictions.

“Climate change is a global challenge and is driving major policy responses and investment decisions around the world. These will have consequences for Australian companies, presenting both risks and opportunities,” Byres said.

“Understanding how, where and over what timeframe these risks will play out is a test for financial regulators, as much as it is for institutions. In response, APRA will continue its collaboration with international peers to gain insights we can use to refine and strengthen our understanding, and ensure Australian financial institutions are appropriately managing those risks.”

The CVA information paper is available on APRA’s website at: Climate Vulnerability Assessment.

The CVA will measure the impact on individual institutions and the financial system of two different plausible future scenarios for how climate change, and the global response to it, may unfold.

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