The heat is on: A framework for measuring financial stress under disruptive energy transition scenarios

Vermeulen, Robert; Schets, Edo; Lohuis, Melanie; Kölbl, Barbara; Jansen, David‐Jan; Heeringa, Willem

doi:10.1016/j.ecolecon.2021.107205

Cited by 46 publications

(38 citation statements)

References 20 publications

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“…For example, Denmark’s central bank conducted a study of mortgage lending risks resulting from projected sea-level rise in 2019 and a scenario analysis of the sensitivity of banks’ capital positions to an abrupt transition, characterized by a substantial impairment charge over a short timeframe, in 2020 [ 129 , 130 ]. Similarly, the central bank of the Netherlands was an early leader in climate scenario analyses, assessing weather-related physical risks and disorderly energy transition risks via policy and technology shocks for banks, insurers, and pension funds in 2017 and 2018, respectively [ 127 , 128 ]. Scenario analyses have leveraged diverse data sources (e.g., historical natural disaster data, routine supervisory data, bespoke surveys) to provide a high-level assessment of physical and transition risks [ 5 , 21 ].…”

Section: Climate Stress Testing Practicesmentioning

confidence: 99%

Environmental sustainability and financial stability: can macroprudential stress testing measure and mitigate climate-related systemic financial risk?

DeMenno

2022

J Bank Regul

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Despite widespread recognition among financial regulators and central banks that climate change may threaten financial stability, the causes and consequences of climate-related systemic financial risk remain underexplored. Stress testing has emerged as one of the most prevalent regulatory tools for addressing climate-related financial risks, and this article analyzes the role of stress testing in mitigating the effects of climate change on financial stability. Specifically, it synthesizes the multi-disciplinary literature on climate-related financial risk, financial stability, and stress testing to develop a framework for evaluating the capacity and effectiveness of stress tests for measuring and managing climate-related systemic financial risk. It then takes stock of climate stress testing proposals and early practices globally and applies the evaluative framework in comparative case studies of the Bank of England and US Federal Reserve. It concludes that stress testing can support the measurement and management of both microprudential and macroprudential climate-related financial risks, but the benefits of stress testing vis-à-vis climate change and financial stability are largely unrealized. Addressing the disconnect between climate stress testing policy motivation and implementation as well as the divergence between leading and lagging jurisdictions will require both interagency and international regulatory cooperation.

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Section: Climate Stress Testing Practicesmentioning

confidence: 99%

Environmental sustainability and financial stability: can macroprudential stress testing measure and mitigate climate-related systemic financial risk?

DeMenno

2022

J Bank Regul

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“…An additional significant role that central banks can play in the evaluation of climate risks is to incorporate climate risks into their stress testing exercises. Such preliminary exercises have already been conducted (see, for example, Battiston et al, 2017;2 o Investing Initiative, 2019;Vermeulen et al, 2019;Allen et al, 2020;Baudino and Svoronos, 2021). The purpose of climate stress tests is to examine the vulnerability of the financial system to climate-related financial shocks linked with physical or transition risks (see NGFS, 2020b).…”

Section: The Risk Exposure Approachmentioning

confidence: 99%

Climate change, central banking and financial supervision: beyond the risk exposure approach

Dafermos¹

2022

Monetary Policy in the United States and Its Impact on the Functional Distribution of Income: 1970-2015

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It is now increasingly accepted that central banks and financial supervisors can no longer ignore climate change. However, there is no consensus on how they should address climate issues. On the one hand, there is a view that central banks and financial supervisors should mainly contribute to the assessment of the exposure of the financial system to climate-related financial risks, considering at the same time the possibility of incorporating climate risks into monetary policy and financial supervision and regulation. On the other hand, it is argued that central banks and financial supervisors need to take action such that they contribute directly to the decarbonisation of our economies and the prevention of climate systemic risks. In this paper, I analyse the main premises and implications of these two approaches and I explain why a systemic risk approach is necessary in the age of climate emergency. I also discuss the challenges involved in a policy agenda aiming at the reduction of climate systemic risks and I outline how these challenges can be tackled.

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“…Energy transition risks can and should be limited and mitigated in at least two ways. First, Vermeulen et al [49] recommend reducing the vulnerability of financial institutes by performing stress tests that consider the energy sector's role. Since climate-related stress testing is a relatively new and immature research field, it comes with challenges.…”

Section: Transmission Of Risks To the Energy Transitionmentioning

confidence: 99%

Geopolitical and climate risks threaten financial stability and energy transitions

Franziska¹,

Hoffart²,

D’Orazio³

et al. 2022

Preprint

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We propose a framework to unravel the hurdles and opportunities for the renewable energy transition in contemporary crises to examine the interconnections between energy transition, climate risks, and geopolitical issues. The study focuses on Germany and emphasizes that neglecting climate-related risks leads to financial instability and hampers the energy transition. If Parisaligned energy and financial policies are not in place, further cascade (negative) effects on energy transitions may occur. Uncertainty and instability caused by geopolitical crises intensify negative feedback loops. Climate mitigation is thus critical because climate concerns affect financial stability and the orderly path of energy transitions.

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The heat is on: A framework for measuring financial stress under disruptive energy transition scenarios

Cited by 46 publications

References 20 publications

Environmental sustainability and financial stability: can macroprudential stress testing measure and mitigate climate-related systemic financial risk?

Environmental sustainability and financial stability: can macroprudential stress testing measure and mitigate climate-related systemic financial risk?

Climate change, central banking and financial supervision: beyond the risk exposure approach

Geopolitical and climate risks threaten financial stability and energy transitions

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