Carbon Risk and Financial Institutions

Carbon risk impacts systematic risk because the transition away from high-carbon production systems will have economy-wide effects (see Battiston et al. (2017) and Dietz et al. (2018)). While the magnitude of climate-related financial risks is highly uncertain, there is consensus that carbon risk already impacts financial institutions and will continue to do so. Thus, risk-management approaches have to be developed to extend standard risk-management practice to cope with carbon risk. We present a brief introduction to this topic, review the role of central banks in this context, and describe stress tests, which are a major tool to assess carbon risk.