Australia’s banks can weather climate risk – RBA research

Australia’s financial system will be able to manage credit loss caused by climate change, but uncertainties around the extent of transition and physical risks remain.

In an article for the Reserve Bank of Australia’s (RBA) quarterly bulletin, researchers estimate the risks climate change poses to banks’ housing and business exposures.

Kellie Bellrose, David Norman and Michelle Royters note one potentially large exposure from climate change is mortgages, which account for approximately two-thirds of Australian major banks’ portfolios.

To estimate the exposure to physical risks, the authors combine disaggregated climate risk forecasts with micro-level data on banks’ mortgage exposures.

“Our results suggest that climate change results in around 400,000 more loans having a loan-to-value ratio (LVR) greater than 80%,” the researchers say. Half of these loans would have an LVR of greater than 90%.

Currently, most of Australia’s climate risk is concentrated in a small number of regions, mostly agricultural or coastal areas. However, the risks in these regions could increase if house buyers find that insurance is difficult to access or becomes too expensive.

“By 2050, only around 1.5% of properties are projected to experience a rise in annual insurance premiums that could reduce housing values by around 10% or more,” the research says.

The RBA’s research also notes banks are exposed to transition risks through lending to “emissions-intensive” industries. However, these banks’ portfolios tend to be less emission-intensive than the Australian economy as a whole.

“The risks facing domestic banks appear manageable, but there are considerable uncertainties and limitations to this analysis,” the researchers conclude.

The authors note their analysis has certain limitations and should be viewed as complementary to the Australian Prudential Regulatory Authority’s (Apra) upcoming stress tests – the Climate Vulnerability Assessment.

“The risks to banks’ portfolios may be overstated in this exercise because we assume that banks’ exposures will not change in the future,” the authors say. “In reality, banks are expected to increasingly incorporate climate risks into their lending decisions.”

Unlike climate stress tests, which have been carried out by regulators in France and the UK, Apra’s exercise requires Australia’s five largest banks to take both a “static” and “proportional” balance sheet approach to calculating climate-related financial impacts.

Under the static approach, banks will have to measure climate exposures against their current lending portfolios. However, the proportional approach allows them to assume limited changes to the composition of their loan books over the stress tests’ time horizons.

Apra says it will publish the findings of its stress test in early 2022.