Climate risk stress-testing: Why mid-sized banks must keep it proportionate
With central banks across the Middle East increasingly integrating climate-related risks into prudential frameworks, managing these risks is becoming a top priority for banking executives. Monaem Ben Lellahom, CEO of Sustainable Square, explains why banks must now be transparent about how climate change could impact their portfolios, capital, and disclosures.
What Regulators Are Asking For
Regulators across the Middle East are converging on climate, governance, stress-testing, and disclosure as supervisory priorities:
CBUAE – United Arab Emirates issued Principles for the Effective Management of Climate-Related Financial Risks, referencing NGFS scenarios and requiring stress-testing, governance, and disclosure. This places the UAE among the first in the Middle East to formalize expectations around climate stress.
SAMA – Saudi Arabia has issued Rules on Stress Testing, requiring all banks in Saudi Arabia to conduct regular stress tests, including macroeconomic, bottom-up, and reverse stress scenarios, that reflect their size, complexity, and risk profile. The results must be reported to SAMA, with clear governance in place to ensure boards and senior management use them for capital and risk management decisions.
QCB – Qatar released its ESG and Sustainability Strategy, explicitly calling for prudential regulation on climate risks, stress-testing, and sector-wide dashboards. This pushes Middle East banks in Doha to embed scenario analysis into governance, rather than treating it as an add-on.
CBO – Oman issued Circular BM 1208 requiring integration of sustainability into governance, risk, and disclosure frameworks. For Omani banks, and smaller Middle East peers in similar markets, it signals a shift from voluntary ESG to regulatory obligation.
CBB – Bahrain introduced an ESG Module mandating annual ESG reporting with KPIs and recognition of climate risk in disclosures. That makes Bahrain one of the few Middle East regulators to tie climate stress explicitly to external reporting duties.
CBK – Kuwait issued guidelines on sustainable finance and ESG, requiring climate risk to be embedded into lending, risk, and disclosure practices. This is reshaping how Kuwaiti banks and by extension other Middle East institutions with concentrated portfolios, assess sectoral risks.
CBJ – Jordan released Climate Risk Management Instructions (2025) aligned with Basel’s climate risk principles, making stress-testing a supervisory expectation. Jordan joins the Middle East regulatory momentum by showing how non-GCC markets are moving in parallel.
The frameworks often mirror Basel Committee on Banking Supervision (BCBS) and the Network for Greening the Financial System (NGFS) guidance, which were designed with large international banks in mind. For small and mid-size banks in the Middle East, importing heavy stress-testing models is neither realistic nor necessary.
The Misstep: Importing Heavyweight Models
When climate stress-testing entered supervisory agendas, many Middle East banks assumed they had to replicate the complex models used in Europe or Asia. On paper, these frameworks look safe and sophisticated, but they are designed for global giants with deep datasets, large modeling teams, and decades of climate data. For mid-sized banks in the Middle East, the fit is poor.
These imported models demand borrower-level emissions data, high-resolution hazard maps, and multi-decade scenarios that local banks simply don’t have. The outputs often highlight risks irrelevant to Middle East balance sheets while overlooking core exposures like real estate, SMEs, and construction. Boards are then left with charts that cannot be explained or acted upon.
The bigger issue is credibility. A stress test that nobody in the bank can understand or replicate undermines trust with regulators. Instead of building internal capability, banks become reliant on expensive external consultants. What was meant to demonstrate resilience ends up as a black box that drains resources and weakens the institution’s climate-risk posture.
The Smarter Approach: Proportionate, Practical, Explainable
For small and mid-size banks in the Middle East, the smarter move is to build a proportionate framework. The starting point is exposures that actually matter: real estate, construction, SMEs, consumer lending, and energy-linked corporates. These are the portfolios most sensitive to transition and physical risks in the region.
Three straightforward scenarios are enough to begin with, baseline, moderate transition, and severe physical. With these, banks can adjust probability of default and loss given default assumptions, run expected credit losses, and show how results translate into provisions and capital ratios. This creates a clear narrative that boards understand and supervisors value.
Governance is the other piece. A concise climate risk policy, clear board oversight, and a quarterly reporting cycle are often more powerful than a global model. And when results are disclosed, keeping them decision-useful and proportionate ensures consistency and credibility across the Middle East regulatory landscape.
Middle East Examples
In Oman, a mid-size bank with heavy commercial real estate exposure can demonstrate compliance with CBO’s Circular BM 1208 by running a sector-level stress test, showing how property values respond under transition and physical shocks, and linking the results to provisions.
In Bahrain, a retail-focused bank preparing its annual ESG report under the CBB’s ESG Module doesn’t need complex systems. A clear stress test on consumer and mortgage portfolios, tied directly to ESG KPIs, shows climate risk integration in disclosures.
In Kuwait, a corporate lender with exposure to construction and energy-linked sectors can apply CBK’s ESG guidance by stress-testing these industries for transition risks. Demonstrating how results shape lending policies positions the bank as aligned with regulatory expectations while staying proportionate.
These are examples of banks in the Middle East showing supervisors and boards that climate risk can be managed with clarity and proportionality rather than unnecessary complexity.
Why This Matters
The Middle East is moving quickly on climate risk, but it is also pragmatic. Regulators understand that local banks differ in size, capacity, and data maturity. They are not demanding that a mid-tier lender in Muscat, Manama, or Kuwait City behave like a European systemically important bank. What they want is evidence of understanding, proportionate stress-testing, and readiness to act as expectations evolve.
For smaller institutions, credibility comes not from complexity but from clarity. A bank that can walk its board and regulator through exposures, explain how simple scenarios affect losses, and show the capital impact will always be ahead of the curve. That is the path that builds trust, with regulators, with markets, and with the communities these banks serve across the Middle East.
