Introduction

• The Basel Committee on Banking Supervision formed a Task Force on Climate-related Financial Risks to tackle such risks in the banking industry. They reviewed existing initiatives and issued reports on the risks associated with climate change. The Committee is currently looking at how the Basel Framework can address these risks. The Principles for effective management and supervision of climate-related financial risks offer guidance for banks and supervisors to improve risk management and are adaptable to different banking systems.

• Banks of all sizes and business models face climate-related financial risks, which can impact traditional financial risk categories. Banks should assess the materiality of these risks and manage them in proportion to their activities and risk tolerance.

• Climate risks have complex and wide-ranging impacts that vary by sector and geography, and may materialize over varying time horizons. Banks should develop dynamic risk management capacities to address these uncertainties and consider different time horizons in risk assessment and scenario analysis. Board and senior management should take a long-term view of climate-related financial risks and continuously develop their capabilities to manage them.

• These principles do not prescribe a specific board structure.

1. Principles for Governance and Internal Control

Corporate governance–

Principle 1– Banks should develop and implement a sound process for understanding and assessing the potential impacts ofclimate-related risk drivers on their businesses andon the environments in whichthey operate. Banks should consider material climate-related financial risks that could materialize over various time horizons and incorporate these risks into their overall business strategies and risk management frameworks.

• Banks must factor in physical and transition risks when creating business strategies, assessing impact on resilience, objectives, and exposure to changes in the economy and financial system due to climate- related risks. The board and senior management should be involved and communicate their approach to managers and employees.
• Board and senior management should assess if climate-related financial risks in the bank’s strategy and risk management require changes in compensation policies, aligned with the bank’s objectives and values.
• Banks’ risk management frameworks must align with their goals and objectives, and boards and senior management should ensure consistency between internal strategies and publicly communicated climate commitments.

Principle 2– The board and senior management should clearly assign climate-related responsibilities to members and/or committees and exercise effective oversight of climate-related financial risks. Further,the board and senior management should identify responsibilities for climate-related risk management throughout the organizational structure.

• Board members or committees should be clearly given the task of managing climate-related financial risks to ensure they are properly integrated into the bank’s strategy and risk management framework.
• Banks must ensure that the board and senior management understand climate-related financial risks and possess the necessary skills and experience to manage them. If required, banks should provide training through workshops or external expert organizations.
• Clear definitions and explicit assignments of roles and responsibilities for identifying and managing climate-related financial risks should be made throughout the bank’s organizational structure. Adequate resources and expertise should be provided to enable effective fulfillment of responsibilities, and if dedicated climate units are established, their responsibilities and interactions with existing governance structures should be clearly defined.

Principle 3– Banks should adopt appropriate policies, procedures and controls that are implementedacross the entire organisation to ensure effective management of climate-related financial risks.

• Embedding management of material climate-related financial risks into policies, processes, and controls should be done across all relevant functions and business units, such as in client onboarding and transaction assessment.

Internal control framework –

Principle 4– Banks should incorporate climate-related financial risks into their internal controlframeworks across the three lines of defence to ensure sound, comprehensive and effective identification, measurement and mitigation of material climate-related financial risks.

• A clear definition and assignment of climate-related responsibilities and reporting lines should be included in the internal control framework across all three lines of defence.

• Climate-related risk assessments may be conducted by the first line of defence during various processes such as client onboarding, credit application and review, and ongoing monitoring and engagement. Additionally, potential climate-related financial risks should be identified by first-line staff who possess sufficient awareness and understanding.
• Responsibility for independent climate-related risk assessment and monitoring should lie with the second line of defence, with the risk function. They should challenge the initial assessment conducted by the first line of defence, while adherence to applicable rules and regulations should be ensured by the compliance function.
• The internal audit function, as the third line of defence, should provide an independent review and assurance of the internal control framework, systems, and risk governance framework. This includes assessing the quality and effectiveness of the first and second lines of defence, as well as changes in methodology, business, and risk profile. Data quality should also be evaluated.

• PRINCIPLES FOR CAPITAL AND LIQUIDITY ADEQUACY AND RISK MANAGEMENT PROCESS

2. Principles for Capital and Liquidity Adequacy and Risk Management Process

Capital and liquidity adequacy –

Principle 5– Banks should identify and quantify climate-related financial risks and incorporate those assessed as material over relevant time horizons into their internal capital and liquidity adequacy assessment processes, including their stress testing programmes where appropriate.

• Banks must assess the potential solvency impact of climate-related financial risks on their capital planning horizons. Material risks that could harm their capital position over relevant time horizons should be evaluated, including their impact on traditional risk categories. These risks should be included in the internal capital adequacy assessment process.
• Banks should assess climate-related financial risks that could cause net cash outflows or reduce liquidity buffers under normal and stressed scenarios. They must evaluate material risks that could impair liquidity and include them in their internal liquidity adequacy assessment process.
• When assessing climate-related financial risks that are material over relevant time horizons, banks should include physical and transition risks that are relevant to their business model, exposure profile, and strategy. Incorporating these risks into stress testing programs enables banks to evaluate their financial position under severe yet plausible scenarios.
• Banks will integrate climate-related financial risks into their internal assessments over time as methodologies and data evolve. To start, they should identify relevant risk drivers, create indicators to quantify exposures, and assess connections to traditional financial risks.

Risk management proce  –

Principle 6– Banks should identify, monitor and manage all climate-related financial risks that could materially impair their financial condition, including their capital resources and liquidity positions. Banks should ensure that their risk appetite and risk management frameworks consider all material climate- related financial risks to which they are exposed and establish a reliable approach to identifying, measuring, monitoring and managing those risks.

• If climate-related financial risks are material, the board and senior management must define and address them in the bank’s risk appetite framework.

• Banks must regularly assess climate-related financial risks and set clear definitions and thresholds for materiality, considering concentrations related to industry, sectors, and regions. They should establish key risk indicators that align with monitoring and escalation arrangements for effective management of these risks.
• Banks may consider risk mitigation measures, such as setting internal limits for material climate-related financial risks in their risk profiles.
• As climate-related risks continue to evolve, banks should monitor and manage their impact on traditional financial risk categories. New transmission channels may emerge, so banks should stay updated and adjust their risk management strategies accordingly.

• PRINCIPLES FOR MANAGEMENT MONITORING AND REPORTING, COMPREHENSIVE MANAGEMENT OF CREDIT AND OTHER RISKS, AND SCENARIO ANALYSIS

3. Principles for Management Monitoring and Reporting, Comprehensive Management of Credit and Other Risks, and Scenario Analysis

Management monitoring and reporting –

Principle 7– Risk data aggregation capabilities and internal risk reporting practices should account for climate-related financial risks. Banks should seek to ensure that their internal reporting systems are capable of monitoring material climate-related financial risks and producing timely information to ensure effective board and senior management decision-making.

• Banks must include climate-related financial risks in their risk data aggregation capabilities to identify and report exposures, concentrations, and emerging risks. This involves collecting and aggregating climate-related financial risk data across the banking group, ensuring data accuracy and reliability, and investing in data infrastructure and systems as needed.
• Banks should engage clients and counterparties to better understand their transition strategies and risk profiles. If reliable climate-related data is not available, banks may use reasonable proxies and assumptions as alternatives for internal reporting.
• Banks should regularly update their internal risk reports to reflect the evolving nature of climate-related financial risks, with a focus on timeliness.
• Banks should create metrics or indicators to evaluate, track, and communicate climate-related financial risks. Constraints that hinder full assessment of climate risk data should be transparently disclosed to stakeholders when appropriate.

Comprehensive m nagement of credit risk –

Principle 8– Banks should understand the impact of climate-related risk drivers on their credit risk profiles and ensure that credit risk management systems and processes consider material climate-relatedfinancial risks.

• Banks need to have clear credit policies and processes to identify and manage material climate-related credit risks. This includes incorporating climate-related financial risks into the entire credit life cycle, including client due diligence and ongoing monitoring of their risk profiles.
• Banks should assess and monitor concentrations within and between risk types associated with climate-related financial risks using metrics or heatmaps to evaluate exposure to geographies and sectors with higher climate-related risk.

• Banks should mitigate material climate-related credit risks by adjusting underwriting criteria, engaging with clients, imposing loan restrictions, setting limits on exposures that do not align with business strategy or risk appetite, or applying alternative risk mitigation techniques.

Comprehensive management of market, liquidity, operational and other risks –

Principle 9– Banks should understand the impact of climate-related risk drivers on their market risk positions and ensure that market risk management systems and processes consider material climate- related financial risks.

• Banks should understand the impact of climate-related risk drivers on their market risk positions and ensure that market risk management systems and processes consider material climate-related financial risks.
• A sudden shock scenario could help banks better understand and assess the relevance of climate- related financial risks to their trading book. This scenario could include variations in liquidity across assets exposed to climate-related risk and assumptions about the speed at which exposures could be closed out.
• Banks should consider how the availability and pricing of hedges may change due to different climate and transition pathways, including during a disorderly transition, when evaluating their mark-to-market exposure to climate-related risks.

Principle 10– Banks should understand the impact of climate-related risk drivers on their liquidity risk profiles and ensure that liquidity risk management systems and processes consider material climate- related financial risks.

• Banks must assess the impact of climate-related risks on net cash outflows and the value of assets in their liquidity buffers, and incorporate this information into their liquidity risk management frameworks.

Principle 11 Banks should understand the impact of climate-related risk drivers on their operational risk and ensure that risk management systems and processes consider material climate-related risks. Banks should also understand the impact of climate-related risk drivers on other risks and put in place adequate measures to account for these risks where material. This includes climate-related risk drivers that might lead to increasing strategic, reputational, and regulatory compliance risk, as well as liability costs associated with climate-sensitive investments and businesses.

• Banks should assess the impact of climate-related risks on their operations and business continuity plans. They should analyze how physical risk drivers can affect their ability to provide critical operations and develop plans accordingly.
• The impact of climate-related risk drivers on other risks, such as strategic, reputational, regulatory compliance, and liability risk, should be assessed by banks and taken into account as part of their risk management and strategy-setting processes, where material.

Scenario analysis –

Principle 12– Where appropriate, banks should make use of scenario analysis to assess the resilience of their business models and strategies to a range of plausible climate-related pathways and determine the impact of climate-related risk drivers on their overall risk profile. These analyses should consider physical

and transition risks as drivers of credit, market, operational and liquidity risks over a range of relevanttime horizons.

• The objectives of climate scenario analysis should align with the bank’s overall climate risk management goals established by the board and senior management. These objectives may involve
  • exploring the impacts of climate change and transitioning to a low-carbon economy on the bank’s strategy and business model resilience,
  • identifying relevant climate-related risk factors,
  • measuring vulnerability to such risks and estimating exposures and potential losses,
  • identifying data and methodological limitations in climate risk management, and
  • informing the sufficiency of the bank’s risk management framework, including risk mitigation options.
• Banks should consider how the availability and pricing of hedges may change due to different climate and transition pathways, including during a disorderly transition, when evaluating their mark-to-market exposure to climate-related risks.
• Scenario analysis should cover relevant climate-related financial risks for banks, including physical and/or transition risks relevant to their business model, exposure profile, and strategy. Scenarios should be diverse and plausible, with consideration given to potential benefits and limitations of selected assumptions.
• Banks should have adequate capacity and expertise to conduct climate scenario analysis proportional to their size, business model, and complexity. Larger and more complex banks are expected to have more advanced analytical capability.
• Shorter and longer time horizons should be employed in scenario analysis to address different risk management objectives. The crystallization of risk within a bank’s typical business planning horizon can be analyzed in shorter time frames with lower uncertainty, while longer time frames with higher uncertainty can be used to evaluate the resiliency of existing strategies and business models to structural changes in the economy, financial system, or distribution of risks.
• Climate scenario analysis is a dynamic field, expected to evolve rapidly with advances in climate science. Therefore, climate scenario models, frameworks, and results should undergo regular review and be subject to challenge by both internal and external experts and independent functions.

4. Principles for Supervision

Prudential regulatory and supervisory requirements for banks –

Principle13–Supervisorsshoulddeterminethatbanks’incorporationofmaterialclimate-related financial risks into their business strategies, corporate governance and internal control frameworks is sound and comprehensive.

• Supervisors should ensure clear assignment and documentation of roles and responsibilities for climate-related financial risks in relevant policies, procedures, and controls, including for the board and senior management.
• Supervisors should assess board and senior management oversight of climate-related financial risks and verify accurate internal reporting to conduct oversight.
• Supervisors should maintain contact with board and senior management to understand the bank’s long-term approach to climate-related financial risks. They should also challenge assumptions made in setting strategies and business models, as necessary.

• Supervisors should ensure banks address climate-related risk drivers when developing and implementing business strategies, including assessing the resiliency of their business models to material climate-related financial risks over various time horizons and their potential impact on achieving business objectives.
• Supervisors must ensure that banks integrate climate-related financial risks into their corporate governance and internal controls. This includes implementing policies, procedures and controls across the three lines of defence, providing sufficient resources and expertise for relevant functions, and conducting regular reviews of the internal control framework.

Principle 14– Supervisors should determine that banks can adequately identify, monitor and manage all material climate-related financial risks as part of their assessments of banks’ risk appetite and risk management frameworks.

• Supervisors should assess how banks assess the materiality of climate-related financial risks on a regular basis, using appropriate key risk indicators and risk mitigating measures to manage these risks effectively.
• Supervisors should assess if banks’ risk management frameworks consider material climate-related financial risks. They should assess if the banks’ data aggregation capabilities and internal reporting practices can facilitate the identification and reporting of climate-related risk exposures, concentrations, and emerging risks, along with deployment of a range of risk management approaches.

Principle 15– Supervisors should determine the extent to which banks regularly identify and assess the impact of climate-related risk drivers on their risk profile and ensure that material climate-relatedfinancial risks are adequately considered in their managementof credit, market, liquidity, operational,and other types of risk. Supervisors should determine that, where appropriate, banks apply climate scenario analysis.

• Supervisors must ensure that banks consider various mitigation options to manage material climate- related risks. They should also require banks to consider these risks in their internal capital and liquidity adequacy assessments over relevant time horizons.
• Supervisors should ensure banks have a scenario analysis program to assess their resilience to climate- related outcomes, considering their size, business model, and complexity. They should also review and challenge the program’s assumptions, methodologies, and results.

Responsibilities, powers and functions of supervisors –

Principle 16– In conducting supervisory assessments of banks’ management of climate-related financial risks, supervisors should utilize an appropriate range of techniques and tools and adopt adequate follow- up measures in case of material misalignment with supervisory expectations.

• Supervisors should set proportionate expectations for relevant banks based on their activities.
• Supervisors of cross-border banking groups should share information on climate risk resilience using existing frameworks for collaboration to foster cross-border collaboration.

Principle 17– Supervisors should ensure that they have adequate resources and capacity to effectively assess banks’ management of climate-related financial risks.

• Supervisors should regularly review and update their skill sets to match evolving market practices and supervisory needs. If aspects of climate-related risk assessments are outsourced, supervisors should maintain the necessary knowledge to ensure the credibility and realism of the outsourced analysis.

• Supervisors should engage diverse stakeholders to better understand and measure climate-related financial risks and optimize climate-specific resources.
• Supervisors can use regulatory reports to assess climate-related financial risks to banks. If there are data gaps, supervisors may ask for more information from banks, such as sector exposures and internal reports.

Principle 18– Supervisors should consider using climate-related risk scenario analysis to identify relevant risk factors, size portfolio exposures, identify data gaps and inform the adequacy of risk management approaches. Supervisors may also consider the use of climate-related stress testing to evaluate a firm’s financial position under severe but plausible scenarios. Where appropriate, supervisors should consider disclosing the findings of these exercises.

• Supervisors should define clear objectives for supervisory climate scenario analysis, which may include
  • exploring the impact of climate change on banks’ strategies,
  • assessing relevant risk drivers,
  • promoting information-sharing, and
  • evaluating the adequacy of risk management frameworks.
• Supervisors may use climate-related stress testing to assess banks’ financial positions under plausible scenarios. This capability is expected to mature over time as data and methodologies develop.
• Supervisors should consider banks’ material climate-related financial risks, including physical and transition risks, and use a range of plausible climate pathways in their exercises. Time horizons, depending on objectives, could be short- or long-term. Shorter horizons could analyze risks within traditional capital planning horizons, while longer horizons could assess exposure to structural changes.
• Supervisors need expertise to conduct climate-related stress tests. They should collaborate with stakeholders to develop scenarios and stay updated on emerging practices in scenario design.
• Supervisors must acknowledge the limitations of their analyses and engage in ongoing dialogue with banks and other supervisors to gain deeper insights into banks’ climate-related vulnerabilities and their strategies to mitigate these risks as approaches continue to evolve.
• Supervisors must consider the level of uncertainty linked to scenarios before disclosing results. They may disclose results of supervisory exercises with the right level of detail on methodologies, assumptions, the degree of uncertainty, and key sensitivities at an appropriate level of aggregation.
• Existing frameworks for cross-border banking groups should be leveraged, where possible, and frameworks for communicating and coordinating these supervisory exercises with other relevant domestic and cross-jurisdictional authorities should be established, where useful synergies are likely to be yielded. Best practices and the outcome of these supervisory exercises should be shared, subject to applicable legal constraints, and common scenarios should be used where appropriate. Home and host supervisors are encouraged to do this.