Banks first in line for APRA’s climate stress tests

Banks will be the first sector in the firing line for the prudential regulator’s tough new ­climate change stress tests.

Insurance companies fear the rise of physical risks from climate change such as bushfires Picture: AAP

Australian banks will be the first sector in the firing line for the prudential regulator’s tough new ­institutionally focused climate change stress tests, which will be rolled out following the launch of new economic and environmental scenario modelling by global central banks next year.

The Australian Prudential Regulation Authority will then target the $45bn general insurance sector with its audits on the vulnerability of companies to a potentially “disorderly” transition to a low-emissions economy.

Finally, superannuation fund managers overseeing the nation’s $3 trillion pile of retirement savings will feel the heat of APRA’s soon-to-be-launched climate stress tests, which will measure how the funds are preparing their portfolios for an unpredictable ­future in which asset prices could fluctuate wildly depending on the rate of warming of the planet or the policies put in place to achieve emissions targets.

Regulatory sources have confirmed to The Weekend Australian the running order for the sectors soon to face an Australian prudential probe measuring the exposure of banks, insurers and super funds to both the physical risks of climate change — such as floods, droughts, fires or cyclones — and the economic “transition” risks, such as orderly or abrupt changes in prices, possible stranded assets, or long-term productivity changes.

The insights from the stress tests could be used to encourage companies to exit potentially risky assets or investments, reprice policies or loans, or even to force banks and insurers that refuse to ready themselves for an unpredictable climate to hold more capital as a buffer in times of crisis.

The climate models to be used to analyse the financial strength of companies are being developed by an international group of regulators, chaired by Bank of England governor Mark Carney, who this week warned that large financial groups in the UK would imminently face the world’s toughest climate stress tests.

As revealed by The Australian this week, the Network of Central Banks and Supervisors for Greening the Financial System (NGFS), chaired by Mr Carney, is due to finalise a number of climate transition scenarios in the first half of 2020, at which point APRA will begin tuning the economic models to the local context to begin stress testing large financial institutions.

The Reserve Bank, a member of the group, will use the financial models to analyse economy-wide impacts of climate change and policies seeking to shift the nation to a low-emissions future.

The Australian Securities & Investments Commission will also be engaged in the work, mostly through monitoring whether companies are properly disclosing known risks to shareholders.

Mr Carney this week said the BoE would measure UK financial companies against three scenarios, which were under development by the NGFS. “The catastrophic business-as-usual scenario where no further climate action is taken, a scenario where early policy action delivers an orderly transition to the targets set in Paris, and a third where late policy action leads to a disorderly and disruptive transition,” Mr Carney said. This aligns closely to recent remarks by APRA executive Geoff Summerhayes, who chairs the global Sustainable Insurance Forum, who said Australian regulators were contemplating “three broad models” of climate change scenarios and what the ensuing “implications would be for assets and business models” stemming from those scenarios.

“A hothouse world, where there is no discernible change to the warming profile; an orderly adjustment to a lower-carbon future, which would envisage a significant amount of transition risk, albeit smooth; and a late adjustment where the world continues to warm and there is a realisation from a policy sense much later in the piece which requires a very rapid adjustment to a lower-carbon future,” Mr Summerhayes told parliament this month.

“Each of those scenarios has implications for the pricing of assets, for business models, for physical impacts and liability impacts to a range of firms’ investments.”

Fitch Ratings head of sustainable finance Andrew Steel on Friday said the gap between how ambitious global governments pledge to cut emissions and the ­actual policies in place to reach those targets highlighted the “risk of a sharp shift” in the global regulatory environment. Mr Steel said the possibility that global governments could ratchet up carbon pricing policies to meet emissions targets was a key risk to company credit ratings.

The Australian Competition & Consumer Commission on Friday said home insurance in northern Australia was becoming “increasingly unaffordable” and was, on average, double the cost of policies in the rest of the country. Deputy chair Delia Rickard said high insurance prices threatened the “resilience, liveability and prosperity of our northern regions”.

The share of homeowners going without insurance in northern Queensland nearly doubled to 17 per cent between 2011 and 2016. The top end of WA has a non-insurance rate of 40 per cent.

As part of its investigation into rising insurance prices in areas exposed to natural disasters, one local insurer told the ACCC that in “the context of ongoing climate change” it had “limited appetite for concentration risk arising from natural perils”. When too many residents wanted insurance in ­locations vulnerable to climate-­related disasters, it rejected new applications or increased policy prices to reduce its exposure.

“Two insurers also stated that climate change risk and their associated cost allowances will be incrementally incorporated into premiums as customers renew their premiums,” the ACCC said.

Climate-related insurance losses across the world last year were the fourth highest on record at $US76bn ($110bn), according to KPMG, while 2017 was the worst year on record.

In the first survey of its kind, APRA earlier this year found all of the 38 large institutions it surveyed were taking steps to understand the threat of climate change.

A third of the group of banks, insurance companies and superannuation funds believed climate change was an immediate “material financial risk” to their businesses, while 20 companies believed climate change will be a risk in the future.

Four of seven banks said energy-related risks were the most pertinent, while one bank said rising sea levels was its biggest risk. Insurance companies were most concerned by risks such as floods and cyclones. Life insurance firms feared heat stress for customers.