The Role of CRMS in Managing Climate Risks in Banking

Indonesia has Nationally-Determined Contributions (NDC) commitment to reducing Unconditional greenhouse gas (GHG) emission targets to 31.89% and conditional (with support international) to 43.2% compared to business-as-usual (BAU). This  commitment caused Indonesia to develop a long-term strategy for each of its sectors. To support this strategy and commitment, Otoritas Jasa Keuangan (OJK) developed the Climate Risk Management & Scenario Analysis for Banking (CRMS), which provides a structured approach for Indonesian banks to manage climate-related financial risks. This system includes stress testing and scenario analysis to help banks measure and mitigate potential climate impacts.

According to OJKs General and Technical Guidelines on CRMS (2024), the key aspects of CRM include:

1. Governance and Supervision: Strengthening effective oversight by boards of directors and executive management in financial institutions.

2. Risk Identification and Measurement: Implementing risk assessments based on climate-related scenarios, including both physical and transition risks.

3. Strategic Business Adaptation: Encouraging financial institutions to align with Indonesia’s Nationally Determined Contributions (NDCs) under the Paris Agreement.

4. Stress Testing and Scenario Analysis: Conducting bottom-up Climate Risk Stress Testing (CRST) to evaluate the financial resilience of banks under different climate change scenarios.

5. Disclosure and Reporting: Ensuring transparency through compliance with Task Force on Climate-related Financial Disclosures (TCFD) and other sustainability reporting standards.

The Role of Scenario Analysis in Climate Risk Management

Scenario Analysis is a critical tool used by policymakers and financial institutions to evaluate the potential impact of climate change on economic and business activities. The 2024 CRMS Technical Guidelines specify the following aspects:

1. Defining Climate-Related Risk Transmission: Understanding how climate risks affect financial stability through physical risks (e.g., floods, rising temperatures) and transition risks (e.g., carbon pricing, regulatory changes).

2. Developing Climate Scenarios: Adopting scenarios based on the Network for Greening the Financial System (NGFS), including:

• Net Zero 2050 (orderly transition)

• Delayed Transition (disorderly transition)

• Current Policies (hot house scenario)

3. Assessing Financial Implications: Measuring climate risks effects on Probability of Default (PD), Loss Given Default (LGD), Expected Credit Loss (ECL), and Non-Performing Loans (NPL).

4. Integration into Financial Planning: Using climate risk assessments to guide credit allocation, investment planning, and capital adequacy assessments.

Challenges and the Way Forward

There are several challenges that the banking sector will faced when implementing this guidance, this includes:

• Data Limitations and Quality: Improving access to reliable Scope 1, Scope 2, and Scope 3 emissions data for financial institutions.

• Capacity Building: Enhancing banks’ technical capabilities in climate risk modeling and scenario analysis.

• Regulatory and Market Coordination: Ensuring alignment between financial institutions, government agencies, and market participants.

• Green Investment Mobilization: Mobilizing green investments through green financing such as Green Bonds, Sustainability Linked Loan, and other sustainable finance.