The implications of climate change for financial stability

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Report discusses how climate risks might impact, or be amplified by, the financial system.

Building on the FSB Stocktake of financial authorities’ experience in including physical and transition climate risks as part of their financial stability monitoring, this report assesses the channels through which physical and transition risks could impact the financial system and how they might interact. Particular focus is on the potential amplification mechanisms and cross-border effects, and on the channels that could materialise in the short-to-medium term.

Current central estimates of the impact of physical risks on asset prices appear relatively contained but may be subject to considerable tail risk. The manifestation of physical risks could lead to a sharp fall in asset prices and increase in uncertainty. A disorderly transition to a low carbon economy could also have a destabilising effect on the financial system.

Climate-related risks – physical and transition risks – may also affect how the global financial system responds to shocks. They may give rise to abrupt increases in risk premia across a wide range of assets. This could alter asset price (co-)movement across sectors and jurisdictions; amplify credit, liquidity and counterparty risks; and challenge financial risk management in ways that are hard to predict. Such changes may weaken the effectiveness of some current approaches to risk diversification and management. This may in turn affect financial system resilience and lead to a self-reinforcing reduction in bank lending and insurance provision.

There are various actions that financial institutions can take – and are taking – to reduce or manage their exposure to climate-related risks. However, the efficacy of such actions taken by financial firms may also be hampered by a lack of data with which to assess clients’ exposures to climate-related risks, or the magnitude of climate-related effects. Robust risk management might be supported by initiatives to enhance information with which to assess climate-related risk.

The FSB will conduct further work to assess the availability of data through which climate-related risks to financial stability could be monitored, as well as any data gaps.

FSB examines financial stability implications of climate change

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Ref no: 52/2020

The Financial Stability Board (FSB) today published a report that examines the potential implications of climate change for financial stability. The report analyses how climate-related risks might be transmitted across, and might be amplified by, the financial system, including across borders. It also sets out next steps for the FSB’s work in this area.

Current central estimates of the impact of physical risks on asset prices appear relatively contained but may be subject to considerable tail risk. The manifestation of physical risks could lead to a sharp fall in asset prices and increase in uncertainty. A disorderly transition to a low carbon economy could also have a destabilising effect on the financial system.

Climate-related risks – physical and transition risks – may also affect how the global financial system responds to shocks. They may give rise to abrupt increases in risk premia across a wide range of assets. This could alter asset price (co-)movement across sectors and jurisdictions; amplify credit, liquidity and counterparty risks; and challenge financial risk management in ways that are hard to predict. Such changes may weaken the effectiveness of some current approaches to risk diversification and management. This may in turn affect financial system resilience and lead to a self-reinforcing reduction in bank lending and insurance provision.

The breadth and magnitude of climate-related risks might make these effects more pernicious than in the case of other economic risks. Moreover, the interaction of climate-related risks with other macroeconomic vulnerabilities could increase risks to financial stability. For instance, certain emerging market and developing economies that are particularly vulnerable to climate change are also dependent on cross-border bank lending.

There are various actions that financial institutions can take – and are taking – to reduce or manage their exposure to climate-related risks. However, the efficacy of such actions taken by financial firms may be hampered by a lack of data with which to assess clients’ exposures to climate-related risks, or the magnitude of climate-related effects. Robust risk management might be supported by initiatives to enhance information with which to assess climate-related risk.

The FSB will conduct further work to assess the availability of data through which climate-related risks to financial stability could be monitored, as well as any data gaps.

Notes to editors

The 14 October 2020 communique of the G20 Finance Ministers and Central Bank Governors notes that the FSB is continuing to examine the financial stability implications of climate change.

On 22 July 2020, the FSB published a Stocktake of financial authorities’ experience in including physical and transition climate risks as part of their financial stability monitoring.

In April 2015 the G20 asked the FSB to consider climate risk and in December 2015 the FSB launched the industry-led Task Force on Climate-related Financial Disclosures (TCFD) to develop recommendations on climate-related financial disclosures. The TCFD published its final recommendations in June 2017 and its latest status reporton 29 October 2020.

The FSB coordinates at the international level the work of national financial authorities and international standard-setting bodies and develops and promotes the implementation of effective regulatory, supervisory, and other financial sector policies in the interest of financial stability. It brings together national authorities responsible for financial stability in 24 countries and jurisdictions, international financial institutions, sector-specific international groupings of regulators and supervisors, and committees of central bank experts. The FSB also conducts outreach with approximately 70 other jurisdictions through its six Regional Consultative Groups.

The FSB is chaired by Randal K. Quarles, Vice Chairman, US Federal Reserve; its Vice Chair is Klaas Knot, President of De Nederlandsche Bank. The FSB Secretariat is located in Basel, Switzerland, and hosted by the Bank for International Settlements.

Reforming Major Interest Rate Benchmarks: 2020 Progress report

20 November 2020 | PDF full text (787 KB)

Work to transition away from LIBOR needs to accelerate in early 2021.

This report covers reforms to a number of benchmarks, including the key London Inter-bank Offered Rate (LIBOR) benchmark.

During 2020, the disruption to global financial markets associated with the COVID-19 pandemic has further highlighted the fundamental weaknesses in LIBOR and reinforced the critical importance of the FSB’s efforts to reform the production and use of global interest rate benchmarks. While some aspects of firms’ transition plans have been temporarily disrupted or delayed, others have been able to continue, including the release by ISDA of new fallback language for derivative contracts and the publication of market conventions for loans and other products based on risk-free rates in a number of jurisdictions.

Given the extent of risks associated with a failure to prepare adequately for the transition, the onus of action is on firms. Global and national financial regulators will be monitoring progress closely. In October the FSB published a global transition roadmap for LIBOR. The roadmap sets out a timetable of actions for financial and non-financial sector firms to take in order to ensure a smooth LIBOR transition by end-2021.

With only one year left, all market participants – both financial and non-financial firms across the globe – must now ensure they follow the necessary steps to avoid disruption to the performance of their contracts. For transition to occur on time, market participants will need to cease use of LIBOR as a benchmark in all new activity across global markets as soon as possible and this needs to be a key priority for the months ahead.

There have been a number of proposals by authorities and national working groups including in the US, UK and EU to help manage an orderly wind-down of LIBOR and, in particular, provide a legislative solution for tough legacy contracts. However, market participants should continue to progress their transition efforts and plans proactively, particularly through active conversion and the insertion of robust and workable fallbacks where feasible.

Consistent with the above and emphasising the importance of action on this timetable, the administrator of LIBOR, ICE Benchmark Administration (IBA), on 18 November announced that it will consult on its intention that the euro, sterling, Swiss franc and yen LIBOR panels would cease at end-2021. Announcements in relation to US dollar LIBOR are expected to follow. In its role as regulator of IBA, the UK Financial Conduct Authority (FCA) has also set out its potential approach for use of new powers under proposed UK legislation to ensure an orderly wind down of LIBOR and published consultations on its proposed policies for using them.

FSB Official Sector Steering Group (OSSG) Co-Chairs Andrew Bailey and John C. Williams made the following statement: “The message that all market participants should take from this Report and this week’s announcements from the IBA and FCA is that we need to be prepared for the end of LIBOR. Everyone needs to be ready.

We thank all of our colleagues across the OSSG jurisdictions for their support in producing this report, and their commitment to redouble efforts on this issue next year as we approach the culmination of many years of hard work to strengthen the global financial system.”

FSB sets out progress on interest rate benchmark reform

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Ref no: 51/2020

The Financial Stability Board (FSB) today published a progress report on implementation of reforms to major interest rate benchmarks.

 The roadmap sets out a timetable of actions for financial and non-financial sector firms to take in order to ensure a smooth LIBOR transition by end-2021.

With only one year left, all market participants – both financial and non-financial firms across the globe – must now ensure they follow the necessary steps to avoid disruption to the performance of their contracts. For transition to occur on time, market participants will need to cease use of LIBOR as a benchmark in all new activity across global markets as soon as possible and this needs to be a key priority for the months ahead.

There have been a number of proposals by authorities and national working groups including in the US, UK and EU to help manage an orderly wind-down of LIBOR and, in particular, provide a legislative solution for tough legacy contracts. However, market participants should continue to progress their transition efforts and plans proactively, particularly through active conversion and the insertion of robust and workable fallbacks where feasible.

Consistent with the above and emphasising the importance of action on this timetable, the administrator of LIBOR, ICE Benchmark Administration (IBA), on 18 November announced that it will consult on its intention that the euro, sterling, Swiss franc and yen LIBOR panels would cease at end-2021. Announcements in relation to US dollar LIBOR are expected to follow. In its role as regulator of IBA, the UK Financial Conduct Authority (FCA) has also set out its potential approach for use of new powers under proposed UK legislation to ensure an orderly wind down of LIBOR and published consultations on its proposed policies for using them.

FSB Official Sector Steering Group (OSSG) Co-Chairs Andrew Bailey and John C. Williams made the following statement: “The message that all market participants should take from this Report and this week’s announcements from the IBA and FCA is that we need to be prepared for the end of LIBOR. Everyone needs to be ready.

We thank all of our colleagues across the OSSG jurisdictions for their support in producing this Report, and their commitment to redouble efforts on this issue next year as we approach the culmination of many years of hard work to strengthen the global financial system.”

Notes to editors

In 2014 the FSB made recommendations to reform interbank offered rates (IBORs) in response both to cases of attempted manipulation and to the decline in liquidity in key interbank unsecured funding markets. The FSB and member authorities, through the FSB Official Sector Steering Group (OSSG) chaired by Andrew Bailey (Governor, Bank of England) and John C. Williams (President and CEO, Federal Reserve Bank of New York), are working to implement and monitor these recommendations.

The FSB OSSG will continue its work to monitor and support benchmark transition, and in particular LIBOR transition, efforts throughout 2021. This work will be complemented by the results of an FSB survey on supervisory issues related to benchmark transition, including a data collection to monitor LIBOR exposures, which will feed into a further report on LIBOR transition progress in July 2021.

The FSB coordinates at the international level the work of national financial authorities and international standard-setting bodies and develops and promotes the implementation of effective regulatory, supervisory, and other financial sector policies in the interest of financial stability. It brings together national authorities responsible for financial stability in 24 countries and jurisdictions, international financial institutions, sector-specific international groupings of regulators and supervisors, and committees of central bank experts. The FSB also conducts outreach with approximately 70 other jurisdictions through its six Regional Consultative Groups.

The FSB is chaired by Randal K. Quarles, Vice Chairman, US Federal Reserve; its Vice Chair is Klaas Knot, President of De Nederlandsche Bank. The FSB Secretariat is located in Basel, Switzerland, and hosted by the Bank for International Settlements.

2020 Resolution Report: “Be prepared”

18 November 2020 | PDF full text (2 MB)

Resolution preparedness remains a key priority.

This report updates on progress in implementing policy measures to enhance the resolvability of systemically important financial institutions and highlights the need for resolution preparedness. It also discusses lessons learnt from the COVID-19 pandemic, which confirmed the importance of ongoing work on resolvability, including for central counterparties (CCPs).

  • Banks – Global systemically important banks (G-SIBs) are estimated to already meet the final 2022 minimum external total loss absorbing capacity (TLAC) requirement. While disclosure of external TLAC levels by G-SIBs has improved over the past year, little information is available to market participants on the distribution of TLAC within banking groups. Work is ongoing on the management, distribution and transferability of these resources.

  • CCPs – Recent periods of market turmoil have demonstrated the benefits that central clearing brings for global financial stability. A review by the CPMI and the IOSCO qualified thirteen CCPs as systemically important in more than one jurisdiction. Enhancing the resilience of CCPs remains an FSB priority.

  • Insurance – Progress on implementation of national insurance resolution regimes has slowed down, with no significant reforms, such as finalisation of new or enhanced insurance resolution frameworks, reported in this recent cycle. A number of jurisdictions have identified systemically important insurers for purposes of recovery and resolution planning. Key areas of attention for FSB work on resolution planning for insurers are intra-group interconnectedness and funding in resolution.

FSB highlights need for resolution preparedness

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Ref no: 50/2020

The Financial Stability Board (FSB) today published its 2020 Resolution Report. The report updates on progress in implementing policy measures to enhance the resolvability of systemically important financial institutions and highlights the need for resolution preparedness. It also discusses lessons learnt from the COVID-19 pandemic, which confirmed the importance of ongoing work on resolvability, including for central counterparties (CCPs).

  • Banks – Global systemically important banks (G-SIBs) are estimated to already meet the final 2022 minimum external total loss absorbing capacity (TLAC) requirement. TLAC-eligible bond issuance has continued through the difficult COVID-19 pandemic environment, and the market has so far absorbed issuance without difficulty. Disclosure of external TLAC levels by G-SIBs has improved over the past year. There is still however little information available to market participants on the distribution of TLAC within banking groups. Work is ongoing on the management, distribution and transferability of these resources.
  • CCPs – Recent periods of market turmoil have demonstrated the benefits that central clearing brings for global financial stability. The Committee on Payments and Market Infrastructures (CPMI) and the International Organization of Securities Commissions (IOSCO) coordinated a review, which qualified thirteen CCPs as systemically important in more than one jurisdiction. Most authorities have established crisis management groups for these CCPs and commenced resolution planning. To support discussions on CCP resolvability and adequacy of financial resources for resolution, the FSB issued Guidance on financial resources to support CCP resolution and on the treatment of CCP equity in resolution. The Chairs of the FSB, CPMI, IOSCO and the FSB Resolution Steering Group agreed to collaborate on and conduct further work on CCP financial resources through their respective committees.
  • Insurance – The FSB continues to monitor implementation of the Key Attributes for the insurance sector. Progress on implementation of national insurance resolution regimes has slowed down, with no significant reforms, such as finalisation of new or enhanced insurance resolution frameworks, reported in this recent cycle. A number of jurisdictions have identified systemically important insurers for purposes of recovery and resolution planning. Key areas of attention for FSB work on resolution planning for insurers are intra-group interconnectedness and funding in resolution.

Notes to editors

The FSB coordinates at the international level the work of national financial authorities and international standard-setting bodies and develops and promotes the implementation of effective regulatory, supervisory, and other financial sector policies in the interest of financial stability. It brings together national authorities responsible for financial stability in 24 countries and jurisdictions, international financial institutions, sector-specific international groupings of regulators and supervisors, and committees of central bank experts. The FSB also conducts outreach with approximately 70 other jurisdictions through its six Regional Consultative Groups.

The FSB is chaired by Randal K. Quarles, Vice Chairman, US Federal Reserve; its Vice Chair is Klaas Knot, President of De Nederlandsche Bank. The FSB Secretariat is located in Basel, Switzerland, and hosted by the Bank for International Settlements.

Holistic Review of the March Market Turmoil

17 November 2020 | PDF full text (2 MB)

March market turmoil highlights the need for action to address vulnerabilities from non-bank financial intermediation.

This report, which was delivered to G20 Leaders ahead of their November Summit, provides a holistic review of the March market turmoil. The breadth and dynamics of the economic shock and related liquidity stress in March were unprecedented. The shock caused a fundamental repricing of risk and a heightened demand for safe assets. The stress also led to large and persistent imbalances in the demand for, and supply of, liquidity.

Particular activities and mechanisms in the financial system acted as mitigants or propagators of the liquidity stress. Central counterparties remained resilient despite market turbulence, though margin calls may have been larger than expected in some cases. Some investors in open-ended investment funds may have faced incentives to redeem ahead of others. While stronger bank capital and liquidity positions, built over the past decade as a result of the post-crisis reforms, helped to prevent a sharp rise in counterparty risks, banks may have been unwilling or unable to deploy substantial balance sheet capacity in an uncertain and volatile environment. Dealers also faced difficulties absorbing large sales of assets, amplifying turmoil in short-term funding markets. Market dysfunction was exacerbated by the substantial sales of US Treasuries by some leveraged non-bank investors and foreign holders. Absent central bank intervention, it is highly likely that the stress in the financial system would have worsened significantly.

The March turmoil underscores the need to strengthen the resilience of non-bank financial intermediation (NBFI). The review sets out an NBFI work programme, focusing on three main areas: work to examine and address specific risk factors and markets that contributed to amplification of the shock; enhancing understanding of systemic risks in NBFI and the financial system as a whole, including interactions between banks and non-banks and cross-border spill-overs; and assessing policies to address systemic risks in NBFI.

FSB Chair’s letter to G20 Leaders: November 2020

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FSB has acted to address vulnerabilities in the financial system exposed by COVID-19.

This letter from the FSB Chair, Randal K. Quarles, to G20 Leaders ahead of their November Summit, notes that while financial conditions have continued to ease the global economic outlook remains uncertain and financial stability risks elevated. The letter sets out three responses to financial stability vulnerabilities highlighted by COVID-19: 

  • Coming to a shared diagnosis – the letter notes that the market turmoil in March manifested itself differently in countries around the world. Emerging market economies experienced severe strains in offshore US dollar funding markets; whereas some advanced economies experienced significant outflows from certain types of investments. The FSB’s holistic review assesses the initial stages of the COVID-19 Event as having exposed a number of common strengths and vulnerabilities across the global financial system.
  • The need for continued vigilance and policy support – the challenges posed by the COVID Event have by no means dissipated yet. Persistent economic uncertainty and still elevated financial stability risks call for continued vigilance. The FSB continues to carefully monitor for signs of emerging vulnerabilities. The protracted nature of the COVID Event requires continued efforts to support financial resilience and ensure a sustained flow of financing to the real economy.
  • Enhancing financial sector resilience going forward – the COVID-19 Event has provided an opportunity to further assess financial stability risks and to refine measures put in place after the 2008 global financial crisis, where appropriate. These lessons can help strengthen financial sector resilience to better prepare for future shocks.

FSB acts to address issues highlighted by March market turmoil

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Ref no: 49/2020

The Financial Stability Board (FSB) today published a letter from its Chair and two reports delivered to G20 Leaders ahead of their Summit this week:

  • Chair’s letter – FSB Chair Randal K. Quarles notes the FSB will continue to act to address vulnerabilities in the financial system exposed by COVID-19 and new and emerging risks. While financial conditions have continued to ease, persistent economic uncertainty and still elevated financial stability risks call for continued vigilance. The protracted nature of the COVID Event requires continued efforts to support financial resilience and ensure a sustained flow of financing to the real economy. Addressing the vulnerabilities exposed by the COVID Event and making progress on other important topics ranging from cross-border payments to LIBOR will require continued strong commitment and coordination at the international level.

  • Holistic Review – the Review finds that the breadth and dynamics of the economic shock and related liquidity stress in March were unprecedented. The March turmoil underscores the need to strengthen the resilience of non-bank financial intermediation (NBFI). The review sets out an NBFI work programme, which focuses on three main areas: work to examine and address specific risk factors and markets that contributed to amplification of the shock; enhancing understanding of systemic risks in NBFI and the financial system as a whole, including interactions between banks and non-banks and cross-border spill-overs; and assessing policies to address systemic risks in NBFI.

  • COVID-19 pandemic: Financial stability impact and policy responses – risks to global financial stability remain elevated. Volatility in equity prices has increased recently against the backdrop of a second wave of the pandemic and further containment measures in some regions. Financial conditions may therefore remain vulnerable to sharp shifts in investor sentiment. The effectiveness of the policy response to COVID-19 critically depends on measures taken remaining in place as long as necessary. Heightened economic uncertainty and continued elevated risks to financial stability reinforce the case for continued close international cooperation to help maintain global financial stability, keep markets open and functioning, and preserve the financial system’s capacity to finance growth.

Notes to editors

The FSB coordinates at the international level the work of national financial authorities and international standard-setting bodies and develops and promotes the implementation of effective regulatory, supervisory, and other financial sector policies in the interest of financial stability. It brings together national authorities responsible for financial stability in 24 countries and jurisdictions, international financial institutions, sector-specific international groupings of regulators and supervisors, and committees of central bank experts. The FSB also conducts outreach with approximately 70 other jurisdictions through its six Regional Consultative Groups.

The FSB is chaired by Randal K. Quarles, Vice Chairman, US Federal Reserve; its Vice Chair is Klaas Knot, President of De Nederlandsche Bank. The FSB Secretariat is located in Basel, Switzerland, and hosted by the Bank for International Settlements.