Prudential transition plans can be used in financial supervision and macroprudential monitoring to overcome some of the challenges inherent to assessing the climate-related financial risks that stem from the transition to a low-carbon economy. These challenges include the poor availability and consistency of data, modelling constraints, and the long time horizon over which risks may materialise. Prudential transition plans can provide supervisors with a multi-year account of financial institutions’ risk management strategies to mitigate transition risks and incorporate these risks within the supervisory time horizon, and result in a truer reflection of climate-related financial risks within the prudential framework.
If prudential transition plans are to be integrated into the prudential framework, it must be done in a manner that is proportional to the risks faced by financial institutions. This means accounting for the size of financial institutions and the threat they pose to financial stability, as well as their exposures to transition-sensitive sectors and overall transition risks.
The reporting of transition plans could be integrated into several tools within the supervisory and prudential toolbox, including the large exposures framework, stress testing, risk management under the Basel Framework Pillar II, and disclosure under Pillar III.