The State Bank of Pakistan (SBP) has introduced a comprehensive climate stress testing framework aimed at strengthening the capacity of banks and other regulated financial institutions to measure and manage climate-related risks. The move, announced in a recent circular, responds to growing concerns about the vulnerability of Pakistan’s financial system to climate change, which presents both physical and transition risks to economic stability.
Under the newly issued Guidelines on Climate Stress Testing, the SBP has mandated that all regulated institutions, including commercial banks, development finance institutions, and microfinance banks, integrate climate-related shocks into their existing risk assessment processes. These climate-centric scenarios will complement the ongoing standard stress testing practices that financial institutions currently undertake, thereby expanding the scope of risk evaluation to include long-term environmental threats.
The guidelines require financial institutions to apply single-factor climate shocks, which cover both physical risks, such as extreme weather events and climatic disruptions, and transition risks related to the shift toward a low-carbon economy. By introducing these additional stress scenarios, the central bank aims to ensure that institutions are equipped to evaluate the potential impact of climate dynamics on their lending portfolios, asset quality, and overall financial position.
A key component of the framework focuses on Domestic Systemically Important Banks (D-SIBs), which were previously identified under the SBP’s D-SIBs Framework of 2018. These major banks will now be expected to incorporate climate-related risk factors into their annual macro stress testing exercises. The intention is to assess how significant climate events could affect not just individual institutions but the broader financial system, ensuring systemic stability in the face of environmental challenges.
The timeline for implementation is phased. Financial institutions are required to perform climate stress tests on data as of end-December every year, with the first round expected to be completed by the end of the third quarter of calendar year 2026 using end-December 2025 data. D-SIBs, in particular, will have to conduct annual macro stress tests based on audited financial statements as of December 31 each year and submit the results, inclusive of climate risk scenarios, to the SBP by June 30 of the following year.
In addition to obligating financial institutions to strengthen their risk analysis, the SBP itself will conduct in-house climate stress testing as part of its supervisory mechanism. This parallel framework will allow the central bank’s supervisory teams to engage with institutions directly, review their methodologies, and, where necessary, work with them on risk mitigation strategies or contingency planning based on the results.
The SBP has also issued a broader Regulatory Framework for Effective Management of Climate-related Financial Risks to ensure that climate risk considerations are embedded deeply within institutional governance, business strategy, and risk management systems. Under this framework, all financial institutions must develop board-approved plans that outline time-bound actions and targets for integrating climate risk into their operational and strategic processes. These implementation plans are to be submitted to the SBP by September 30, 2026.
Full compliance with the regulatory framework is required by June 30, 2029, providing a multi-year horizon for financial institutions to build the necessary capabilities, reporting systems, and risk management processes to address climate-related financial risks effectively. The extended timeline reflects the complexity of integrating environmental risk into traditional financial risk frameworks and allows institutions to align their long-term strategic planning with climate resilience objectives.
By pioneering climate stress testing in Pakistan’s banking landscape, the SBP has taken a significant step toward enhancing the resilience of the financial sector while signaling to markets the importance of integrating environmental risk into financial decision-making. As climate threats continue to evolve, these regulatory measures position Pakistan’s banking system to better anticipate and adapt to future challenges.
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