THE Monetary Authority of Singapore (MAS) will step up efforts to improve the financial sector’s climate risk assessment capabilities as an analysis suggests that a disorderly transition could be destabilising for the financial system.

A disorderly transition is when concerted climate policy action begins only in 2026, as opposed to a smooth transition scenario, which assumes that the transition towards a low-carbon future had started this year with governments taking decisive policy action to cut greenhouse gas emissions.

MAS’ analysis – released on Monday (Nov 27) as part of a special feature under the central bank’s latest financial stability review – in particular quantified the significant financial losses banks could face if the disorderly climate transition pans out.

Their aggregate credit costs would amount to 14.2 per cent of their 2022 financial year’s net profits when annualised. This is 50 per cent higher than the credit costs that would hit the banks under a smooth transition, which are estimated to be about 6 per cent of the banks’ FY2022 net profits.

The analysis also found that the banks would incur larger aggregate market losses of 3.1 per cent of their market portfolios under a disorderly transition, compared to 2.2 per cent under a smooth transition.

However, given that banks’ market exposures are small relative to their credit exposures, these losses are correspondingly of a smaller magnitude, amounting to 2.6 per cent and 1.9 per cent of FY2022 net profits, the report pointed out.

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The impact on insurers is not as harsh, but their market losses were still assessed at 4.5 per cent under a disorderly transition, and 2.9 per cent under a smooth transition, according to the report.

These results suggest an urgent need for financial institutions (FIs) to engage their corporate clients to develop and execute credible transition plans to enable an early and orderly transition, MAS said. 

Going forward, MAS will thus step up its efforts to improve internal and industry capabilities in climate risk assessments, it said.

Internally, the efforts would translate to the incorporation of granular forward-looking information, such as corporate transition plans and net-zero targets, in its transition risk assessments and the building up of its physical risk modelling capabilities.

For the industry, MAS will continue to encourage FIs to enhance their climate risk assessment capabilities, including by actively engaging FIs on their progress and plans to address data and methodological gaps that were identified during its climate scenario analysis exercise for selected key banks and insurers last year, it said.

This will enable FIs to better factor the implications of climate change and the climate transition into their internal risk management practices and business decisions, it stated.

MAS, meanwhile, reiterated that it seeks to support the institutions by setting clear supervisory expectations on transition planning, and has released a set of consultation papers proposing relevant guidelines for banks, insurers and asset managers.

“Importantly, the uneven distribution of risks and impact across the financial sector warrants close monitoring, and MAS will continue to assess the financial stability implications of climate transition risks,” it said.