Groups Push Basel Committee to Improve the Use of Scenario Analysis to Blunt Climate Risks

July 16, 2024

Groups Push Basel Committee to Improve the Use of Scenario Analysis to Blunt Climate Risks

WASHINGTON, D.C. - Critical enhancements are needed to the current design and use of climate scenario analysis to be a decision-useful tool for risk management, according to a public comment to the Basel Committee on Banking Supervision (BCBS) from Public Citizen, Americans for Financial Reform Education Fund, and Sierra Club.

"At its best, climate scenario analysis can be used to inform regulatory interventions and financial institutions' transition and adaptation planning," said Mek Belayneh, policy advocate with Public Citizen's Climate Program. "It should not be used as a tool to create a false sense of security regarding irreversible and existential climate risks. Given the radical uncertainty and complexity of climate risk, accurate modeling may be impossible, and efforts to fill data gaps and build modeling complexity may not yield precise risk predictions. Scenario analysis should provide insights into how to mitigate climate risk and ensure financial stability by acknowledging how financial institutions contribute to climate risk through underwriting, financing, and investing in fossil fuels."

Climate scenario analysis, which is a tool for estimating the long-term effects of climate change on banks and other financial institutions, must be improved to make it a better tool for banking supervisors' practices, allowing them to better estimate climate-related financial risks. In May, the U.S. Federal Reserve released results of a pilot climate scenario analysis it undertook with the six largest banks to build its own and the banks' capacity to consider climate-related financial risks, which revealed numerous data and methodological problems.

"There is a growing awareness that climate scenario analysis, though a useful tool, will not be sufficient to capture the full landscape of climate-related financial risks," said Alex Martin, policy director for climate finance at Americans for Financial Reform Education Fund. "Regulators should continue to refine these exercises to build banks' risk management capabilities and spot vulnerabilities, but they also must take immediate and decisive actions to lower overall risk to banks and the financial system."

Basel Committee on Banking Supervision, the international standard setter for banking supervision, has sought consultation on a discussion paper related to the use of climate scenario analysis to identify and manage climate-related financial risk. The comment the organizations submitted today called on BCBS to address limitations in the design of scenario analysis exercises and flaws in the scenarios available from leading providers. The groups also highlighted the need for financial institutions and regulators to move beyond scenario analysis as solely a predictive and exploratory tool and incorporate scenario analysis as a "how to" tool for bank transition planning and adaptation.