Climatic stress tests

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Stress tests programs are born in the 90s and are one of the most preferred tools used by supervisors and financial institutions to assess risk management and insure financial stability, in particularly the adequacy of financial portfolios with prudential requirements when occuring an economic or financial downturn. Methodology is actually limited when these programs want to anticipate the consequences of climate change: a longer time horizon, high uncertainty about future climate events, diversity of impacts according to sectors and geographic areas, etc. Central banks and supervisors are gradually including climate risks in their stress tests scenarios, since a first exercise carried out by the Bank of Netherlands in 2018. Since 2020, the Bank of France and the French Authority of prudential control and resolution (ACPR) are also carrying out a pilot climate exercise with banks and insurance companies.

The Finance ClimAct project contributes to develop capacity of financial institutions and supervisors to realize stress tests programs, with production of guidelines and development of appropriate tools and metrics, and thus allow them to better understand financial risks related to climate change. As such, this approach is a priority of the European Commission Action Plan on Sustainable Finance and of the French National Low Carbon Strategy for measuring climate risks.

To do this, the members of the consortium working on this action – ADEME, I4CE, 2DII, F4T and ACPR, will work on the development and improvement of tools, methods and guidelines necessary for the development of frameworks allowing the implementation of climatic stress tests. By capitalizing on their own research, their tools and the work in progress, the members of this working group will propose, in this framework, approaches and analysis schemes, with the publishing of articles and reports.

Thus, as part of the Finance ClimAct project, 2DII is expected to capitalize on the work that the think-tank has already carried out with various supervisors by continuing to co-develop its models with financial institutions and by making them available to them via additional PACTA modules and other tools. Indeed, 2DII has already developed several reference tools for financial supervisors and central banks aming at perform climatic stress tests at the level of the entities they regulate (Bank of England, California Department of Insurance, European Insurance Authority and occupational pensions (AEAPP) etc.). The dissemination of these models to financial institutions, in particular via working groups gathered by F4T, will facilitate the implementation of climate stress-test exercises in France and more widely across Europe.

In parallel, I4CE and ADEME will work in collaboration with the Banque de France and more generally the Network for Greening the Financial System (NGFS) network to produce methodological work in this area, encouraging the rise in skills and the inclusion of sectoral and macroeconomic effects, in particular based on the Three-ME model co-developed by ADEME, OFCE and TNO. The objective is to build on the relationships between energy, economy and emissions to decline the impacts of global climate scenarios to a sufficiently fine sectoral level.

This crossed approach aims at improving the current methodologies andd, beyond that, the knowledge of banks, insurance companies, supervisors and central banks in the field of climate risk management and the development of future stress-tests programs.