Climate PPNR: how global warming affects bank revenues and expenses

In a traditional bank stress test, the exercise is split into two components.  The one that garners the most attention is credit losses, which I described in a fair amount of detail in my most recent article.  The second component is pre-provision net revenue (PPNR), which ostensibly covers the entire income statement of the institution, excluding the provisions for credit losses covered by the first component.

For a climate stress test to be comprehensive, both components have to be considered.

But if you google “ppnr climate change” (without the quotations, ignoring all the sponsored links) you don’t see any discussion of PPNR by the Network for Greening the Financial System, by major regulators, or by the Basel Committee on Banking Supervision. 

In fact, the most relevant result is a paper I wrote for GARP back in 2019.  In that piece, I sketched out the possible connection between extreme weather and PPNR, but didn’t go into detail.  Another relevant result is a New York Fed Staff Paper on Climate Stress Testing by the noted finance academic Viral Acharya and a number of colleagues (including Nobel laureate Robert Engle).  They discuss PPNR as a core component of stress testing but do not consider it in the context of climate risk.  Indeed, “PPNR” only crops up twice in their article, and never in reference to global warming.

So after almost a decade of climate-related stress testing, no-one in the financial industry has bothered to explore the “other” core component of banking risk.  Well, apart from cursory hat tips from some of the most esteemed thinkers in the industry 🙂 (humblebrag much? – Louie).  

It’s time for this to change.  I’ll make a start.