Newsletter on the implementation of the Principles for the effective management and supervision of climate-related financial risks

• Following the publication of the Principles in June 2022, supervisory authorities and banks have made progress on implementing the Principles, but further work is needed.
• Full implementation will require ongoing effort and adequate resourcing by banks and supervisors to improve capabilities and expertise.
• While the methodologies and data used to analyse climate-related financial risks are still evolving, improving the availability and quality of data should be an ongoing area of focus. Where reliable or comparable climate-related data are not available, banks are encouraged to consider using reasonable proxies and assumptions as alternatives in their internal reporting as an intermediate step, acknowledging the limitations and sensitivities of risk outcomes.
• The Committee places a high priority on work related to climate-related financial risks and will continue to monitor progress to support implementation as soon as possible.

The Committee published the Principles, which seek to improve banks' climate-related financial risk management and supervisors' practices, as part of its holistic approach to addressing climate-related financial risks to the global banking system. The Committee expects implementation of the Principles as soon as possible and is monitoring progress across member jurisdictions to promote a common understanding of supervisory expectations and to support the development and harmonisation of strong practices across jurisdictions. It intends to continue to publish the results of future work in this area. More generally, work in relation to climate-related financial risks remains a priority for the Basel Committee and is a key theme of its 2023–24 work programme.

In the first 12 months following publication, the Committee facilitated sharing of supervisory experiences and practices and engaged with industry to understand progress and identify key challenges to full implementation. The majority of member jurisdictions have taken steps to implement the Principles in domestic supervisory frameworks and practices through the issuance of draft or final guidance, or have plans to issue such guidance.

Supervisors noted that banks lacked the capacity to fully implement the Principles in the first 12 months. However, supervisors observed that a number of principles have at least been partially implemented by banks, including corporate governance (Principles 1–3), internal control frameworks (Principle 4), risk management processes (Principle 6), management, monitoring and reporting (Principle 7), and comprehensive management of credit risk (Principle 8). Adequate resourcing is required to improve capabilities and expertise and to continue to strengthen practices.

The Principles acknowledge that the management of climate-related financial risks is evolving, and practices are expected to mature over time. Supervisors thus identified a number of areas where progress was particularly lagging behind, especially in relation to the quantification of climate-related financial risks, data collection and adequate measurement through reliable risk metrics and key risk indicators. While it is recognised that climate-related financial risks will probably be incorporated into banks' internal capital and liquidity adequacy assessments iteratively and progressively, implementation of Principle 5 (capital and liquidity adequacy) was found to generally be at very early stages. Most supervisors noted that there has been no progress by banks to include climate-related capital and liquidity impacts into existing assessment processes. Data availability and quality have made full implementation more challenging and should be an area of focus for both banks and supervisors going forward.

Areas of focus

Enhancing data availability and quality

Data limitations were identified as the main impediment for banks and supervisors to implement the Principles. Banks reported that the availability and quality of data and methodologies vary significantly across sectors and counterparties, and therefore significant human resources, expertise and time are required to improve data availability and quality. Banks will need to invest in better tools and greater automation to capture climate data and minimise operational risks associated with manual processes.

Supervisors highlighted various initiatives to address data issues. Some supervisors have started collecting quantitative climate-related financial risk data on either a regular or an ad hoc basis (eg during climate scenario analysis or stress testing exercises). Some supervisors also report that they are collaborating with the industry to develop common platforms, templates for data collection, tools and data repositories, some of which are publicly available (eg to assess physical risk impacts or to estimate greenhouse gas emissions).

Banks use targeted questionnaires and client due diligence as part of onboarding to collect qualitative and quantitative data from clients at a counterparty, facility or asset level. In addition to obtaining information from clients, banks also rely on public disclosures and third-party data providers, as well as proxies using activity-based data and asset-based factors. While banks may consider using reasonable proxies and assumptions where reliable or comparable climate-related data are not available, they should understand and establish the necessary guardrails to manage the limitations and sensitivity of risk outcomes.

The Committee encourages ongoing efforts, including in cooperation with supervisors, to overcome data issues.

Building capabilities

Both banks and supervisors need to further develop their capabilities and expertise. A large majority of supervisors stated that banks did not have sufficient capabilities to fully implement the Principles in the first 12 months. In particular, supervised banks lacked the required professional experience and human capital.

Supervisors are working to address their own resource limitations, for instance by building centres of excellence or convening supervisors in dedicated forums. Supervisors' efforts to implement the Principles have also focused on understanding bank practices, identifying risks and establishing supervisory expectations for these risks. Early-stage efforts involved engaging in dialogue with banks, conducting surveys of bank practices, requesting that banks undertake self-assessments and publishing examples of good practices. A number of supervisors noted that next steps would involve conducting targeted or thematic reviews and on-site inspections, providing feedback to banks and integrating climate-related financial risks into core supervisory processes.

The Committee encourages banks' ongoing efforts to strengthen their in-house expertise in order to decrease their reliance on external sources, integrate the measurement and mitigation of climate-related risks into their risk management practices and improve client engagement and due diligence. Given that managing climate-related risks requires multidisciplinary knowledge, expertise needs to be drawn from multiple risk areas across the institutions (ie credit, market, operational, legal, strategic etc). Banks reported efforts to build industry-specific subject matter expertise to understand challenges within specific industries and counterparties. The development of such expertise is crucial to assessing counterparties' current and projected exposures to climate-related financial risks.

Applying climate scenario analysis

Banks confirmed the importance of climate scenario analysis and reported running a range of different scenarios for different purposes, such as for obtaining inputs into their respective risk management frameworks, strategic planning and public disclosure purposes. However, the uses and methodologies vary across jurisdictions and firms, and data availability and methodological uncertainty can be a limiting factor.

Supervisory climate scenario exercises have been a catalyst for building banks' resources and capability. These exercises have also helped to identify data and methodological gaps. They are considered a good complement to banks' internal climate scenario exercises, but not a replacement. These exercises also acknowledge the need and relevance for supervisors and banks to closely collaborate to overcome challenges in addressing climate-related financial risks.