Climate Change and the Role of Regulatory Capital: a Stylized Framework for Policy Assessment

This article presents a stylized, non-country-specific framework to assess conceptually how the financial risks of climate change could interact with a regulatory capital regime. We summarize core features of a bank capital regime such as expected and unexpected losses, minimum capital ratios, buffers, and risk-weighted assets, and then consider where climate-related risk drivers may be relevant. While climate change could potentially impact the regulatory capital regime in several ways, an internally coherent approach requires a strong link between specific assumptions about how financial risks may manifest as bank losses and what objectives regulators are pursuing. We conclude by identifying the challenges that climate-related uncertainties pose to policymakers and highlighting potential research opportunities to better understand these complex issues and inform policy development.