Climate stress test highlights bank risks

Banks face climate risk challenges

Climate stress test highlights bank risks

The 2023 Climate Stress Test evaluated the financial impacts of climate-related risks on major New Zealand banks, revealing significant costs to shareholders and highlighting the need for improved risk management strategies, according to a Reserve Bank bulletin research article.

The 2023 Climate Stress Test, this year's primary assessment for banks, included major institutions such as ANZ Bank New Zealand, ASB Bank, Bank of New Zealand, Kiwibank, and Westpac New Zealand, which together account for about 90% of total bank lending in New Zealand.

Scenario design: Too Little Too Late

Developed in collaboration with banks, New Zealand climate experts, and regulators, the Too Little Too Late scenario integrated high physical risks from climate change, such as floods and droughts, with significant transition risks from global and domestic decarbonisation efforts. Spanning from 2023 to 2050, the scenario reflects the long-term nature of climate risks, contrasting with the short-term economic shocks of past stress tests.

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Financial impact on banks

According to the stress test results, while the Too Little Too Late scenario did not threaten the solvency or overall financial stability of the banks, it significantly affected their financial health.

“It did come at a significant cost to shareholders, with modelled dividends nearly 40% lower and profits 25% lower than in a base case scenario absent climate risks,” the report said.

Additionally, aggregate impairment expenses were five times higher than the base case, highlighting the severe financial toll of unmitigated climate risks.

Capability improvements and strategic actions

The stress test was resource-intensive but beneficial, leading to significant improvements in banks’ capabilities to manage climate risks.

The improvements included better climate-relevant data sourcing, enhanced modelling, and strategic actions aimed at supporting customers’ transition to a lower carbon economy.

Banks also recognised the need to embed climate expertise across their organisations more deeply.

Recommendations for future risk management

The report concluded with several recommendations to further enhance banks’ readiness for climate-related challenges.

These include addressing significant data gaps, continuing the development of credit risk modelling that incorporates climate-risk variables, and finding cost-effective ways to track the insurance status of mortgages.

These steps are vital for banks to better prepare for and mitigate the impacts of climate change on their operations and financial stability.

To download the 2023 Climate Stress Test results, visit the RBNZ website.

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