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The Use Of Credit Risk Weights For Climate-related Purposes – Bulletin Article

The Reserve Bank of New Zealand – Te Pūtea Matua has published a Bulletin article discussing the use of credit risk weights for climate-related purposes.

Te Pūtea Matua is responsible for maintaining a stable financial system to promote the prosperity and well-being of New Zealanders. As climate change poses risks to the stability of the financial system, we have a role to play in ensuring entities manage their climate-related risks

“The understanding of how climate-related risks can impact financial stability is rapidly evolving. We are working with our stakeholders and monitoring international best practice to ensure climate-related risks are understood and adequately managed to meet our financial stability objective,” Director Prudential Policy Kate Le Quesne says.

Our prudential framework requires banks to risk weight their exposures as part of meeting capital requirements. These settings help to ensure banks are resilient in the face of shocks to support financial stability.

This Bulletin:

  • provides an overview of the Reserve Bank’s general approach to credit risk weights;
  • explains what climate-related risks are and their links to credit risks to individual banks and financial stability at a system-wide level;
  • outlines how the Reserve Bank’s credit risk weights framework currently incorporates climate-related risks within its general approach to credit risk; and
  • outlines other tools that the Reserve Bank uses to help entities manage climate-related risks to financial stability.
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Read the Bulletin here.

We will also continue to employ the other tools available to us to enable all of our prudentially regulated entities to manage climate-related risks to the financial system, noting our efforts comprise one part of the system-wide approach to addressing the current and potential impacts of climate change.

What are risk weights?

Risk weights are used to convert the actual size of an exposure into a risk-weighted asset. A more risky exposure will have a higher risk weight. Banks are required to hold a minimum percentage of capital against these risk weighted exposures. Higher risk exposures mean a bank will need more capital — money provided by the owners (shareholders) of a bank. This ensures that the owners have a meaningful stake in the bank — the more the bank’s owners have to lose, the more they will want to make sure the bank is run properly.

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