Major banks pass RBNZ climate stress test scenario but with profits slashed

Each year stress tests are run to assess banks’ resilience, says director of financial stability assessment & strategy Kerry Watt. Last year’s key stress-test for New Zealand’s five largest banks featured a scenario called ‘Too Little Too Late' that stressed their ability to withstand severe but plausible long-term climate-related challenges.

Watt says the test was deliberately challenging and included high physical and transition risks over a prolonged period of 28 years. “Our aim was to assess the financial impact of the scenario on the banks’ balance sheets and uplift their capability in managing climate related risks.”

The results showed that the Too Little Too Late' scenario didn’t threaten bank solvency, as all banks were able to maintain their capital ratios. “However, it did highlight that climate-related risks have the potential to significantly reduce bank profitability, raise risk-weighted assets and reduce shareholders’ returns over the medium to long term. This tells us that climate related risks need to be actively managed to protect the resilience of the system to other shocks.

“The stress test also improved banks’ capability in managing climate-related risks in several areas. These include modelling, sourcing of climate relevant data, informing insurance retreat impacts, embedding climate expertise widely across the organisation and identifying strategic actions to mitigate the risks.”

The RBNZ recommends that banks address significant remaining data gaps, continue the development of credit risk modelling using climate-risk variables, and consider cost-effective ways of tracking the insurance status of mortgages.

It expects all banks to reflect on these recommendations and is considering how it might support banks that did not participate in the stress test to incorporate them into their risk monitoring and management activity.

“It's important to recognise the Too Little Too Late scenario represents only one way New Zealand’s climate scenario could play out. Banks will consider others as part of their own internal risk management and to feed into mandatory climate-related disclosures,” says Watt.