NGFS publishes research on green/brown risk differentials ahead of launching climate data group

Central banking group issues two climate reports as French supervisor publishes outline for pilot stress tests

Frank Elderson, Chair of The Network of Central Banks and Supervisors for Greening the Financial System (NGFS), says it will create a new workstream on climate and environmental data – in yet another major move on the topic in recent weeks.

Financial giants State Street, BlackRock and Allianz have all announced they are leading separate initiatives to drive consistency and comparability over the past couple of months. Speaking to RI, Elderson, also an Executive Board Member at the Dutch central bank DNB, said there was a lack of good climate data, a need for harmonisation. 

The NGFS released two reports on climate risk management today. The first focuses on 54 financial institutions’ (49 banks and five insurers) and whether they identify a risk differential between green and brown financial assets. 

For the past three years, there have been calls from some corners of the financial markets to revise capital requirements for banks, to reflect a belief that green assets carry less financial risk. The European Banking Authority said in December it would explore the possibility of such a “green supporting factor”. Others support a ‘brown penalising factor’, which would require tighter capital requirements for lending to fossil fuels, rather than looser ones for green assets. But efforts on all sides have been held back by the lack of evidence on the correlation between ‘greenness’ and credit risk. 

The NGFS report finds that a lack of data and a harmonised green and brown taxonomy means it is hard to be conclusive on the existence of a risk differential. 

Elderson says the report showed that “the great majority of firms incorporate in their risks management, climate-related risk and environmental risk”. 

The second NGFS report focuses on financial sector supervisors. “It shows that many supervisors around the world have taken steps to incorporate climate and also environmental-related risks,” said Elderson. “Some are a little less advanced, but this report will help all of them to learn from each other.”

The next reports from the NGFS will focus on climate scenario-analysis, he added. 

The NGFS also announced 12 new members including the Austrian Financial Market Authority, Central Bank of West African States and Banco Central do Brasil.

The NGFS, which launched in 2017, has quickly grown to 66 central banks and 12 observers. The US Fed is notably not a member. This month 42 members of US Congress wrote to Fed Chair Jay Powell calling for it to join the NGFS. 

The network has faced civil society pressure recently, with NGOs urging it to make a “call to action” to its members on monetary policy and climate change. They warn, in a letter, that new central banks’ stimulus QE packages to tackle economic pressure are set to support high carbon emitters and contribute to a delay in climate action. The World Resources Institute also recently called for quantitative easing (QE) programmes to consider climate change. 

Elderson said: “‘We received it [the letter] and took note of it, while we are looking deeper into the role central banks and supervisors can play regarding the much needed green recovery.”

"In the case of climate-related risks, the ‘business as usual’ scenario…is probably still likely at present. However, it is the origin of major physical risks. It is therefore rather an adverse scenario whose risks are worth studying" – France’s ACPR

Meanwhile, the French prudential supervision authority has published a provisional set of climate scenarios that will be used to stress test insurers’ and banks’ balance sheets later this year.

For the pilot stress testing exercise, the country’s Autorité de Contrôle Prudentiel et de Résolution (ACPR), the prudential supervisory authority for banks and insurers set up in 2010 following the global financial crisis, has three transition scenarios: an orderly transition “baseline” scenario”, a delayed transition scenario, and a rapid and brutal transition scenario – as well as a physical risk scenario based on “business as usual”.

Participation in the climate pilot exercise will be carried out on a voluntary basis “given the exploratory nature of the exercise”.

The baseline scenario – an orderly transition with reduced transition and physical risks – was chosen in collaboration with the French banks and insurers which participated in preparatory work. The paper explains: “A baseline scenario generally reflects the most likely macroeconomic outlook. In the case of climate-related risks, the ‘business as usual’ scenario…is probably still likely at present. However, it is the origin of major physical risks. It is therefore rather an adverse scenario whose risks are worth studying.” The selected baseline scenario also roughly aligns with France's national low-carbon strategy. 

According to the document, the Banque de France and ACPR have developed a France-specific analytical framework to generate the macroeconomic and sectoral data needed, building on the NGFS scenario data, which currently only provides this information aggregated into large blocks of countries.

The provisional assumptions are open for consultation until June 19, shortly after which point, the final scenarios will be published. Banks and insurers that are participating in the pilot will then have the second half of 2020 to assess the impact of these assumptions and scenarios on their balance sheets. The aggregated results will be published in April 2021. 

The scenarios were published on the same day as a best practice guide for banks on how to incorporate climate risk into governance and risk management frameworks, developed in collaboration with key lenders in France. 

It recommends the use of climate scenario analysis,TCFD alignment and engagement with the EU Non-Financial Reporting Directive. It says that banks “should collect and centralise the data needed to assess the risks posed by counterparties” – although it echoes Elderson in noting that scarce and unstandardised climate data “complicates the assessment of risks”. 

“As regards the transition risk, institutions should in particular aim at systematically collecting data on the carbon footprint of the businesses they finance. As regards the physical risk, institutions should, based on available data, seek to identify the share of counterparties' assets located in vulnerable geographical areas that are more subject to that risk.” The IIGCC today launched guidance on monitoring and managing physical climate risk.

According to the guide, institutions should be working towards using quantitative risk indicators, but can use qualitative measures in the meantime. 

On strategy and governance, it makes a string of recommendations, including the establishment of “a dedicated committee relying on advice from…experts [like] the scientific community [to] assist the management bodies in defining and monitoring a climate risk strategy”, and the appointment of climate risk correspondents for each business line. 

The NGFS reports and the guidance from ACPR come just a week after the European Central Bank (ECB) revealed it expects banks to assess and disclose climate and environmental risk as early as this year in a consultation asking for feedback from the industry on new guidelines.