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Davis Polk Discusses Key Takeaways for Banks of Basel Climate Report

Here are the key takeaways from the Basel Committee’s final Principles for the Effective Management and Supervision of Climate-Related Financial Risks (the “Basel Principles”).

  1. The core elements of the Basel Principles align closely with proposed principles from the OCC and FDIC

  1. The principles affirm a tailored approach to climate risk management

  1. The Basel Principles contemplate banks assessing climate-related financial risks using existing risk categories and risk management oversight and control structures, but with a documented focus on climate change

  1. The Basel Principles suggest using “risk concentrations” to identify and manage climate-related financial risks

  1. The Basel Principles recognize current limitations on the data used to analyze climate-related financial risks

  1. Banks are encouraged to incorporate climate-related financial risks in their ICAAPs and ILAAPs

  1. The Basel Principles contemplate both company-run and supervisory climate-related risk scenario analysis and stress testing

For banks

For supervisors

  1. The Basel Principles encourage international data sharing among the regulators

The Basel Principles state that “[t]o foster cross-border collaboration, home and host supervisors of cross-border banking groups should share information related to the climate risk resilience of banks and banking groups, leveraging existing frameworks for sharing information and undertaking collaborative work.”31

ENDNOTES

1 Basel Committee on Banking Supervision, Principles for the Effective Management and Supervision of Climate-Related Risks (June 2022), https://www.bis.org/bcbs/publ/d532.pdf (hereinafter the “Basel Principles”).  The Basel Principles build on two reports issued by the BCBS in April 2021: Climate-Related Risk Drivers and Their Transmission Channelshttps://www.bis.org/bcbs/publ/d517.pdf (hereinafter the “Risk Drivers Report”) and Climate-Related Financial Risks – Measurement Methodologieshttps://www.bis.org/bcbs/publ/d518.pdf (hereinafter the “Methodologies Report”).  The Risk Drivers Report concluded, among other things, that banks are exposed to climate change through two types of climate risk: (1) physical risks (economic costs and losses resulting from the severity and frequency of physical climate risk drivers) and (2) transition risks (risk drivers arising from efforts to reduce greenhouse gas emissions, such as changes in government policies, technological developments and investor sentiment).  See Risk Drivers Report, at 6-8.  The Risk Drivers Report also concluded that the impact of these two categories of risk drivers can be captured through traditional risk categories already used by financial institutions and reflected in the Basel framework, i.e., credit risk, market risk, liquidity risk, operational risk and reputational risk (although this last category is not specifically reflected in either the Basel capital framework or the Basel liquidity framework).  See id. at 1; The Basel Principles, at 2.  The Methodologies Report concluded, among other things, that both banks and supervisors are at an early stage of translating climate-related risks into robustly quantifiable financial risks and that more work needs to be done in two main areas: (1) measurement gaps in the data available for assessing physical and transition risks, and in methods of mapping climate risk drivers to financial exposures, and (2) methodologies for capturing climate-related financial risks need to overcome uncertainties inherent in projections of physical and transition risk drivers, uncertainties arising from data gaps, and uncertainties in the models to be used for quantitatively assessing identified climate risk drivers and their impacts on banks.  See Methodologies Report, at 2-3.

2 Office of the Comptroller of the Currency, Principles for Climate-Related Financial Risk Management for Large Banks (Dec. 21, 2021), https://www.occ.gov/news-issuances/news-releases/2021/nr-occ-2021-138a.pdf (hereinafter the “OCC Proposal”).

3 Federal Deposit Insurance Company, Statement of Principles for Climate-Related Financial Risk Management for Large Financial Institutions, 87 Fed. Reg. 19,507 (Apr. 4, 2022), https://www.federalregister.gov/documents/2022/04/04/2022-07065/statement-of-principles-for-climate-related-financial-risk-management-for-large-financial.

4 The Basel Principles, supra note 1, at 2.

5 Id.

6 See Board of Governors of the Federal Reserve System, Prudential Standards for Large Bank Holding Companies, Savings and Loan Holding Companies, and Foreign Banking Organizations, 84 Fed. Reg. 59,032, 59,035, 59,047 (Nov. 1, 2019), https://www.federalregister.gov/documents/2019/11/01/2019-23662/prudential-standards-for-large-bank-holding-companies-savings-and-loan-holding-companies-and-foreign; Office of the Comptroller of the Currency, Board of Governors of the Federal Reserve System and Federal Deposit Insurance Corporation, Changes to Applicability Thresholds for Regulatory Capital and Liquidity Requirements, 84 Fed. Reg. 59,230, 59,233-34 (Nov. 1, 2019), https:// http://www.federalregister.gov /documents/2019/11/01/2019-23800/changes-to-applicability-thresholds-for-regulatory-capital-and-liquidity-requirements.

7 The Basel Principles, supra note 1, at 2.

8 The OCC Proposal, supra note 2, at 2; 87 Fed. Reg. at 19,509.

9 Letter from N.Y. Dep’t Fin. Servs., Chief Executive Officers or the Equivalents of N.Y. Regulated Fin. Institutions Concerning Climate Change and Financial Risks (Oct. 29, 2020), https://www.dfs.ny.gov/‌industry_guidance/industry_letters/il20201029_climate_change_financial_risksSee also The Basel Principles, supra note 1, at 2 (“Banks should manage climate-related financial risks in a manner that is proportionate to the nature, scale and complexity of their activities and the overall level of risk that each bank is willing to accept.”).

10 The Basel Principles, supra note 1, at 4, 6-7.

11 Id. at 3-4.

12 See id. at 3-5.

13 Id. at 5-6.

14 Id. at 5, n.7.

15 Id. at 6.

16 The OCC Proposal, supra note 2, at 3; 87 Fed. Reg. at 19,510.

17 See Methodologies Report, supra note 1, at 2, 37-39.

18 The Basel Principles, supra note 1, at 2, 4.

19 Id. at 5-6.  To this end, banks may have to invest in data infrastructure and enhance existing systems. In the meantime, limitations that prevent complete climate risk data assessments should be disclosed to stakeholders “where relevant.”  Id. at 6.

20 Id. at 4.

21 d. at 6-7.

22 Id. at 4, 7.

23 The OCC Proposal, supra note 2, at 2; 87 Fed. Reg. at 19,509-10.

24 The Basel Principles, supra note 1, at 7-8.

25 Id. at 4.

26 Id. at 10.

27 Id.

28 Id.

29 Id. at 11.

30 The OCC Proposal, supra note 2, at 4; 87 Fed. Reg. at 19,510.

31 The Basel Principles, supra note 1, at 9.

This post comes to us from Davis, Polk & Wardwell LLP. It is based on the firm’s memorandum, “Basel climate report: Key takeaways for the banking sector,” dated July 29, 2022, and available here.

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