2024 Climate Risk Stress Testing Exercise Methodology Paper

Climate change and its impact on the environment and economic agents may pose material risks to the safety and soundness of financial institutions, giving rise to broader implications to the economy and financial system. Recognising the risk from climate change to the financial system in Malaysia, financial institutions are required to conduct climate risk stress testing to assess potential vulnerabilities to various climate scenarios.

The 2024 Climate Risk Stress Test (CRST) exercise is primarily intended to facilitate financial institutions’ learning and capacity building in addressing risks from climate change. Financial institutions must aim to gain vital hands-on experience in measuring the impact of climate-related risks on their assets, insurance/takaful liabilities and business operations through the 2024 CRST exercise. Although current risk measurement approaches may not yet be sufficiently comprehensive and accurate to produce robust estimates of climate-related risks impact, the 2024 CRST exercise will provide financial institutions an opportunity to refine their existing risk management strategy and explore new stress testing approaches that are relevant for assessing climate-related risks.

More specifically, the 2024 CRST exercise aims to enhance financial institutions’ capabilities in the following areas:
(a) Improve understanding and appreciation among board, senior management, and staff of financial institutions on how the business and operations of the financial institutions could be impacted by climate-related risks;
(b) Explore novel approaches that could lead to better identification and measurement of financial institutions’ exposures at risk to climate change; and
(c) Identify current gaps, specifically those related to data, measurement, methodology, technology, and capabilities, as well as potential solutions to these challenges.

In carrying out the 2024 CRST exercise, financial institutions are strongly encouraged to collaborate with one another to share experiences, build capacity, and collectively address relevant challenges, for example, sharing of climate-related data that may not be widely available. Financial institutions may leverage on existing industry platforms such as the Joint Committee on Climate Change (JC3) for this purpose.

Given the uncertainty surrounding future climate pathways and evolving approaches for identifying and measuring climate-related risks, the Bank expects the climate risk stress test to become a recurring exercise moving forward. Therefore, financial institutions are expected to continue investing in and improving on the foundations that they have built in preparation for the 2024 CRST exercise.

This document belongs to Bank Negara Malaysia (BNM). Full access to the original source is available here: https://www.bnm.gov.my/banking-islamic-banking