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Climate Stress Testing

Author

Listed:
  • Viral V. Acharya
  • Richard Berner
  • Robert Engle
  • Hyeyoon Jung
  • Johannes Stroebel
  • Xuran Zeng
  • Yihao Zhao

Abstract

We explore the design of climate stress tests to assess and manage macroprudential risks from climate change in the financial sector. We review the climate stress scenarios currently employed by regulators, highlighting the need to (i) consider many transition risks as dynamic policy choices; (ii) better understand and incorporate feedback loops between climate change and the economy; and (iii) further explore “compound risk” scenarios in which climate risks co-occur with other risks. We discuss how the process of mapping climate stress scenarios into financial firm outcomes can incorporate existing evidence on the effects of various climate-related risks on credit and market outcomes. We argue that more research is required to (i) identify channels through which plausible scenarios can lead to meaningful short-run impact on credit risks, given typical bank loan maturities; (ii) incorporate bank-lending responses to climate risks; (iii) assess the adequacy of climate risk pricing in financial markets; and (iv) better understand and incorporate the process of expectations formation around the realizations of climate risks. Finally, we discuss the relative advantages and disadvantages of using market-based climate stress tests that can be conducted using publicly available data to complement existing stress testing frameworks.

Suggested Citation

  • Viral V. Acharya & Richard Berner & Robert Engle & Hyeyoon Jung & Johannes Stroebel & Xuran Zeng & Yihao Zhao, 2023. "Climate Stress Testing," Staff Reports 1059, Federal Reserve Bank of New York.
    • Handle: RePEc:fip:fednsr:95943
    Note: Revised June 2023.
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    Citations

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    Cited by:

    1. Andrea Mazzon & Peter Tankov, 2024. "Optimal stopping and divestment timing under scenario ambiguity and learning," Papers 2408.09349, arXiv.org, revised Oct 2024.
    2. Goodell, John W. & Gurdgiev, Constantin & Karim, Sitara & Palma, Alessia, 2024. "Carbon emissions and liquidity management," International Review of Financial Analysis, Elsevier, vol. 95(PA).
    3. Angelidis, Timotheos & Sakkas, Athanasios & Spiliotopoulos, George, 2023. "Climate uncertainty and marginal climate capital needs," Finance Research Letters, Elsevier, vol. 56(C).
    4. Dasol Kim & Luke Olson & Toan Phan, 2024. "Bank Competition and Strategic Adaptation to Climate Change," Working Paper 24-06, Federal Reserve Bank of Richmond.
    5. Brei, Michael & Mohan, Preeya & Perez Barahona, Agustin & Strobl, Eric, 2024. "Transmission of natural disasters to the banking sector: Evidence from thirty years of tropical storms in the Caribbean," Journal of International Money and Finance, Elsevier, vol. 141(C).
    6. Arnita Rishanty & Retno Puspita K. Wicaksono & Rizkia Sari Yudawinata & Siti Kholifatul Rizkiah & Rafi Aquary & Aurellia Puteri Arfita, 2023. "Navigating Climate Transition: Evaluating Exposure And Resilience Of Indonesian Banks’ Portfolios Across High-Emitting Sectors. A Bottom-Up Analysis," Working Papers WP/05/2023, Bank Indonesia.
    7. Stefano Carattini & Giseong Kim & Givi Melkadze & Aude Pommeret, 2023. "Carbon Taxes and Tariffs, Financial Frictions, and International Spillovers," CESifo Working Paper Series 10851, CESifo.
    8. Fuchs, Larissa & Ngyuen, Huyen & Nguyen, Trang & Schaeck, Klaus, 2024. "Climate stress tests, bank lending, and the transition to the carbon-neutral economy," IWH Discussion Papers 9/2024, Halle Institute for Economic Research (IWH), revised 2024.

    More about this item

    Keywords

    climate risk; financial stability; systemic risk;
    All these keywords.

    JEL classification:

    • G1 - Financial Economics - - General Financial Markets
    • G2 - Financial Economics - - Financial Institutions and Services
    • Q54 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Climate; Natural Disasters and their Management; Global Warming

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