Japanese regulator gears up for climate scenario analysis pilot for banks

The Japan Financial Services Agency and 2 Degrees Investing Initiative will test top five banks’ resilience to climate risk

Japanese regulator the Financial Services Agency (JFSA) is preparing for a climate scenario analysis and stress testing pilot covering the country’s five biggest banks, RI has learned.

The banks will share their loan book data with the JFSA, which will then conduct a two-part climate scenario analysis and stress test exercise. 

In collaboration with thinktank the 2 Degrees Investing Initiative (2dii), the country’s financial regulator is expected to publish the results of the analysis in the first quarter of next year – although what exactly will be published is yet to be confirmed. 

The work had been slated for completion during 2020, but saw delays as a result of the Coronavirus pandemic. 

The process will use 2dii’s Paris Alignment Capital Transition Assessment (PACTA) climate scenario analysis models before using a simplified climate stress test. The scenarios published earlier this year by the Network of Central Banks and Supervisors for Greening the Financial System scenarios could also be integrated into the work.

The PACTA model looks at the transitions needed in key climate-relevant sectors, and measures this against the actual capital expenditure, production patterns and technology use of companies to determine how aligned they are with different climate scenarios. Sectors covered include the fossil fuel, utilities, auto and steel industries. The analysis can be used to determine whether or not a portfolio is transitioning. 

The climate stress test part of the work will simulate potential losses for companies that could materialise under different scenarios. 

Switzerland piloted the original PACTA project in 2017, when the government invited domestic pension funds and insurance companies to have the “climate compatibility” of their investments. Earlier this year, Austria revealed it would be using an expanded version of the PACTA tool, with the government inviting financial institutions and institutional investors to submit their portfolios. 

The JFSA is a member of the Network for Greening the Financial System (NGFS), which this year published an initial set of climate scenarios and user guide for integrating climate risk into prudential supervision, with the aim of providing a common reference framework for central banks and supervisors to understand transition and physical risk under varying assumptions.

The NGFS also published a paper on the potential impact of climate change on monetary policy, which found that climate change and its mitigation will increasingly affect macroeconomic variables essential to the conduct of monetary policy. It highlights the need for central banks to strengthen their analytical toolkits, integrating climate risks into their economic models and forecasting tools.