LIFE STRESS

Climate stress-tests and scenario analysis by financial supervisors has proliferated over the past few years. They are now either piloted or planned by most financial supervisors / central banks across Europe. Notable examples include work by the Bank of England, Banque de France, EIOPA, and the European Central Bank. The Network for Greening the Financial System (NGFS) is a coalition of supervisors and central banks driving this agenda forward and coordinating at international level. These analytical exercises, while in their infancy, are set to make a tremendous contribution to the integration of climate risk considerations by financial institutions. The EU has put these types of exercises at both the heart of the EU Sustainable Finance Action Plan and the Renewed Sustainable Finance Strategy under the Green New Deal.

In an uncertain future, these scenarios provide pathways that the world may follow as it confronts the challenge of climate change. As the sophistication of climate risk assessments increases, regulatory expectations grow, and financial institutions commit to net-zero targets, the relevance of climate scenarios for the financial sector continues to rise. Given the emerging importance of these scenarios, it is imperative that users fully understand the nature of climate scenarios, and that scenario designers appreciate the financial sector applications of their work. Ongoing dialogue between modellers and financial sector users will result both in better integration of these scenarios into financial decision-making and continued enhancement of the scenarios themselves. However, the translation of these ‘economic climate scenarios’ into ‘financial climate scenarios’ remains a challenge. Current approaches by commercial and non-commercial organisations are either a ‘black box’ or too complex to be understood. A proliferation of different financial scenarios makes it hard to understand differences and which scenarios are best equipped for which use case.