"By performing stress tests, financial institutions will be aware of how big the challenges they may face so that they can control risks and optimize lending structures in a timely manner," said Zeng Gang, deputy director-general of the National Institution for Finance & Development.

"In addition, seeing how big the impact of different low-carbon transition paths will be on financial institutions will help policymakers make a good choice of the path by adopting an economically and financially sustainable model to realize the goal of carbon emissions reduction," Zeng said.

The People's Bank of China, the central bank, completed the first phase of climate risk stress tests at 23 major national banks, said Liu Guiping, deputy governor of the PBOC, in an article published in China Finance, a Beijing-based semimonthly journal, on Friday.

The stress tests analyzed how the introduction of a payment mechanism for carbon emissions will increase loan default probability at companies in three industries, namely coal-fired power, iron and steel, and cement, from now to 2030 due to rising costs and then possibly affect capital adequacy of banks.

To ensure prudence in the tests, the PBOC assumed there is no technological progress in these industries, each company has no bargaining power, and the companies have reached a state of insolvency.

Test results showed that if the three industries do not make low-carbon transitions, the repayment capacity of relevant companies will decline by varying degrees under three stress scenarios. However, as the 23 banks' loans to these industries do not account for a large proportion of their total loans, the overall capital adequacy ratio still meets regulatory requirements under each stress scenario, Liu wrote.

The PBOC will improve stress scenarios and climate risk transmission paths in the tests and further expand their scope to more high-emitting industries.

Liu emphasized that government departments should join forces with financial institutions and companies to continuously improve the reliability and accessibility of climate risk-related data and enhance the consistency of accounting methods in this regard.

Banks need to strengthen their climate risk management capacity, build a statistical system of corporate information on climate risks and carbon emission reductions, and conduct risk monitoring and evaluations, said Zeng with the NIFD.

"Regulators should issue clearer standards, paths and requirements for carbon emission reductions as soon as possible, especially in terms of energy-intensive industries－the energy industry and industrial companies－so that financial institutions can turn explicit policies into the basis for climate risk evaluation," he said.

Zheng Chenyang, a researcher with the BOC Research Institute, said the nonperforming loan ratio of typical coal-fired power companies may increase severalfold in the coming years, up from about 3 percent last year, if high emitting companies fail in the low-carbon transition.

"Banks have been reducing lending to high-emitting companies since 2015 and such loans do not account for a large proportion of total loans nowadays. We are quite optimistic about the probability of success for large State-owned enterprises in the coal industry and the iron and steel industry in making a low-carbon transition. Many large companies adopted clean coal technologies, set clear goals for the transition and created road maps in this regard," Zheng said.

"Apart from gradually cutting loans to the coal industry and to companies that have overcapacity problems, banks are also using technologies like artificial intelligence to evaluate potential risks of high-emitting industries, conducting scenario-based climate risk analyses and strictly following the procedures assessing which corporate client is eligible for access to credit," she added.

Ma Jun, president of the Beijing-based Institute of Finance and Sustainability, advised regulators to require banks to disclose the outstanding balance of their dirty lending that ultimately hurts the environment and the proportion of such lending to the total loans on their books. It is only until banks know the risk exposure of their carbon-intensive assets can they take effective measures to manage the risks, Ma said.