Simplifying climate risk stress testing.
Central banks and financial regulators (CBFR) have an important role in managing climate-related financial risks. Many CBFRs across different jurisdictions are undertaking actions to raise the awareness of climate risks in financial institutes and apply them in their operations.
Apart from measuring climate risks in their lending and trading book exposures, it is crucial to carry out forward-looking analyses through scenarios and make assumptions about future mitigation policy and climate impacts. Central banks also need to provide guidance on analyzing longer-term scenarios (10-15 years) that are more speculative but need a set of assumptions on growth and low discount rates to incorporate the longer-term impacts. Institutions need to consider the below core aspects of climate risk stress testing.
1. Data sourcing and quality controls
2. Risk factor measurement and calculation
3. Dynamic risk metrics calculation
4. Aggregation of climate risk measures