Transition Scenarios for Analyzing Climate-Related Financial Risk

In November 2020, the Bank of Canada launched a pilot project with the Office of the Superintendent of Financial Institutions aimed at better understanding risks to the economy and the financial system related to climate change. Part of this work included developing a set of Canada-relevant climate transition scenarios that explore pathways consistent with achieving certain climate targets. The scenarios vary in terms of two key drivers of climate transition risk: (i) the ambition and timing of climate policy and (ii) the pace of technological change and availability of advanced technologies. To develop the scenarios, we used a suite-of-models approach that linked a computable general equilibrium energy-economy model with two macroeconomic models. The scenarios focus on Canada and the United States because of the material exposure of the Canadian financial sector to these regions. They capture the evolution of the global economy, summarized across 10 emissions-intensive sectors of the economy and across 8 distinct regions of the world. The analysis illustrated the important sectoral restructuring the Canadian and global economies may need to undertake to meet climate targets. The analysis showed that every sector contributes to the transition and that the financial impacts vary across sectors. These impacts depend on how the sectors are impacted by emissions and capital expenditures costs and on how the demand for their products is affected by the decarbonization of economies. The scenarios also shed light on the risks of significant macroeconomic impacts, in particular for commodity-exporting countries like Canada. The economic impacts for Canada are driven mostly by declines in global prices of commodities rather than by domestic policy decisions. Finally, the analysis showed that delaying climate policy action increases the overall economic impacts and risks to financial stability.