The current results of climate stress-tests conducted by financial supervisors and the private sector suggest that climate-related risks are less pronounced than ‘traditional’ risks assessed as part of ‘normal’ stress-test exercises.
Current estimates around potential financial losses from physical climate risk oscillate around 5-10%, although certain institutions may have higher results. By being more ‘conservative’ in the models underpinning these approaches, they cater to the sensitivities of the central banks developing them. However, as a result, they also may hide more extreme outcomes (University of Exeter 2023).
A key challenge in interpreting these outcomes is the extent to which these exercises are limited in their scope of application.
Climate stress-tests (or scenario analyses as they are sometimes called) typically build on the NGFS “Hot House” scenario.
There a number of challenges to this approach however:
• The scenarios represent a ‘central’ estimate under a high-carbon future and not some of the more pessimistic outlooks about the potential economic dislocation that higher temperature outcomes may bring.
• They typically do not consider the additional effects of climate tipping points (physical or social).
• They similarly understate climate risks at lower temperature outcomes as being effectively negligible.
Finally, these scenarios focus exclusively on direct climate impacts and do not take into account the potential social or ecosystem shocks that may arise as a result of climate change.The paper combines academic research on the potential GDP effects of climate change with and without climate tipping points, ecosystem service loss, and social tipping points. It aggregates these risks to develop alternative GDP pathways until 2050 where risks from these factors materialize. These alternative growth pathways are then plugged into a multi-period discount dividend model to simulate implied valuation losses or lower return implications of these scenarios.
This report is part of the LIFE21-GIC-DE-Stress project and was authored by the 1in1000 initiative.
Find out more at life-stress.eu/news.
Disclaimer:
Co-funded by the European Union. Views and opinions expressed are however those of the author(s) only and do not necessarily reflect those of the European Union or CINEA. Neither the European Union nor the granting authority can be held responsible for them.
