Current climate scenario analysis exercises may understate climate exposures and vulnerabilities, warn FSB and NGFS
17 November 2022
The report provides a synthesis of the findings from climate scenario analysis exercises undertaken by financial authorities at the individual firm level, at the level of the different financial sectors, and at the overall financial system level.
The Financial Stability Board (FSB) and Network for Greening the Financial System (NGFS) published today a joint
report outlining initial findings from climate scenario analyses
undertaken by financial authorities to assess climate-related financial
risks. The report draws lessons for effective scenario analysis and
sketches out a global perspective. It has been sent to G20 Leaders ahead
of the Bali Summit.
The report provides a synthesis of the findings from climate scenario
analysis exercises undertaken by financial authorities at the
individual firm level, at the level of the different financial sectors,
and at the overall financial system level. It builds on the NGFS Scenarios in action progress report
as an attempt to evaluate the implications of climate-change-related
developments for the financial system as depicted in climate scenarios.
The report finds that the NGFS Scenarios play a critical role in
providing reference climate macro-financial scenarios and supporting
financial authorities’ climate scenario analysis exercises. While a
majority of these exercises rely on NGFS scenarios, significant
variations in scope and objectives make it difficult to allow a
straightforward comparison of results. However, taken together, the
exercises provide a comprehensive picture on vulnerabilities. The
overarching message from these initial exercises for financial stability
is that, while the impacts of climate risks are not small, they seem to
be concentrated in some sectors and overall, at least at this juncture
and as currently assessed, contained from the perspective of domestic
financial systems.
However, the report notes that tail risks and spill overs associated
with climate change related developments may not be as manageable. In
addition, measures of exposure and vulnerability are likely understated.
Many exercises do not capture second-round effects, potential
non-linearities in climate-related risks, and other potentially large
sources of risk, such as those stemming from an abrupt correction in
asset prices when transition shocks result in fire sales of assets in
exposed sectors.
The report also finds that scenario analysis exercises at this stage
are usefully feeding into policy discussions and are raising awareness.
While critically contributing to risk assessment, the exercises are
still considered exploratory and in most cases do not translate into
micro- or macro-prudential policy action at this stage. Further progress
on bridging data gaps, particularly on improving data availability and
consistency/comparability at the global level, will be key. The report
calls for greater cross-border cooperation – particularly at this early
stage of climate scenario analysis work. It notes that sharing knowledge
and practices, in addition to the issuance of robust guidelines on how
to conduct climate scenario analysis, would decisively support capacity
building efforts, and stresses the important role that FSB, NGFS and
other international organisations can play in that regard.
Klaas Knot, Chair of the FSB and President of De Nederlandsche Bank,
said: “This joint report underscores the importance of work to enhance
the understanding of the financial system vulnerabilities from
climate-related risks, through improved and more forward-looking metrics
for assessing financial institutions’ exposures to climate-related
shocks. A key priority going forward will be to enhance the
understanding of how first-round and second-round effects under
different scenarios could give rise to financial stability concerns.”
Ravi Menon, Chair of NGFS and Managing Director of Monetary Authority
of Singapore, said: “Climate scenario analysis is becoming an
increasingly important tool for central banks and regulators to identify
and assess climate risks in their economies and financial systems. The
significance of these risks has been driven home by the global energy
crisis unleashed by Russia’s invasion of Ukraine and the recent spate of
extreme weather events. The NGFS will continue to refine its scenarios
to be more relevant to a wider range of stakeholders.”
FSB
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