A review of climate modelling in the financial sector finds these exercises may be understating the industry’s exposure to climate-related risks, warns the Financial Stability Board (FSB) and Network for Greening the Financial System (NGFS) in a joint report.
The report, which was sent to the G20 leaders ahead of their latest summit, examines the findings from climate scenario analysis exercises undertaken by financial regulators at the firm level, in different financial sectors and for the overall financial system.
“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,” the organizations said in a release.
However, the report also warned that these exercises likely underestimate the sector’s overall exposures and vulnerabilities.
“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 FSB and NGFS said.
Indeed, they warned that the tail risks and potential spillover effects associated with climate change may not be as manageable as the initial scenario exercises suggest.
“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,” said Klaas Knot, chair of the FSB and president of De Nederlandsche Bank, in a release.
The report noted that, while these kinds of climate scenario analysis exercises are raising awareness, they have not translated into policy action at this point.