Climate Risk Management and Scenario Analysis

The adverse impact of climate change could pose material financial risks to the safety and soundness of financial institutions, with broader implications on the stability of the financial system and hence, could affect the sustainability of domestic economic growth.

In view of the risks that climate change poses for financial stability in the long run, the Bank expects financial institutions to respond–
(a) urgently 1 , through taking early actions to implement changes towards building climate resilience;
(b) strategically, by accounting for how actions today affect future outcomes under a range of scenarios and time horizons over the long term;
(c) comprehensively, when strengthening the risk management frameworks to address these financial risks from climate change. In particular, financial institutions are to manage these risks by recognising the distinctive 2 elements of climate-related risks: far-reaching in breadth and magnitude, foreseeable but highly complex due to uncertainty, nonlinearity, irreversibility and dependency on short-term actions; and
(d) holistically, through greater collaboration across a wider spectrum of stakeholders 3 when managing the systemic impact of climate-related risks. Financial institutions stand to gain from greater collective coordination and harmonisation, notably through industry-wide platforms 4, including those facilitated by the Joint Committee on Climate Change (JC3) and VBI Community of Practitioners.

Recognising the characteristics of climate-related risks, this policy document sets out the principles and specific requirements on the management of climate-related risks by financial institutions, with the aim to enhance the resilience of the financial sector against climate-related risks. The principles are summarised in Appendix 1

Notwithstanding paragraph 1.3, financial institutions may consider applying the principles in managing broader environmental risks, taking into consideration the interlinkages between climate-related and broader environmental risks.

The Bank expects financial institutions to have an effective risk management framework that integrates all material risks, which extends to climate-related risks and their interactions with other risk types. In this regard, the specific requirements in this policy document in relation to climate-related risks complement the Bank’s existing requirements for financial institutions to manage material risks and provide further insights on the consideration of climate-related risks as an integral part of financial institutions’ governance, risk management, ICAAP, stress testing and disclosure practices.

Financial institutions also play a pivotal role in driving a just and orderly transition towards a low-carbon economy. This in turn contributes to longer-term climate resilience of financial institutions and the financial sector. During the transition process, the Bank expects financial institutions to have due regard to actions that they should take to–
(a) mitigate risks surrounding economic dislocation due to abrupt withdrawal of financing from economic sectors or activities that are vulnerable to climate-related risks, which may have potential adverse feedback loops to the wider economy and financial stability;
(b) promote transition5 by customers and counterparties towards more sustainable practices;
(c) expand the financing of climate-related opportunities and sustainable economic activities, including offering new solutions, markets and products to support a low-carbon economy; and
(d) better align business strategies and climate-related targets in supporting global and national commitments 6 to address climate change

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