Stress-Testing for the Transition to a Low-Carbon Economy

IMF News, April 15, 2019

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Remarks by Tobias Adrian, Financial Counsellor and Director of the Monetary and Capital Markets Department, International Monetary Fund.
Joint Workshop by the IMF and De Nederlandsche Bank on Stress-Testing for Climate-Related Risks, April 15, 2019.
Focus: stress-testing for the transition to a low-carbon economy, potential financial-stability implications, and analytical and data priorities.

First: Climate change poses an existential challenge.
- Mark Carney called climate change “the Tragedy of the Horizon.”
- The Intergovernmental Panel on Climate Change report projects global warming of 1.5 to 2 degrees Celsius between 2030 and 2045.
- Climate risks are characterized by fundamental uncertainty, large tail risks, potential catastrophic outcomes, and short windows of opportunity for mitigation.
- Abrupt policy changes and technological breakthroughs could change asset valuations and trigger financial instability.

Second: Climate change can pose financial stability risks.
- Financial system roles: financial protection (insurance, risk sharing) and supporting price signals to redirect finance to clean technologies.
- In disruptive transitions, the financial system can amplify shocks via leverage and interconnectedness.
- The Central Banks and Supervisors Network for Greening the Financial System includes 29 members and identified climate-related risks as a material source of financial risk.

Third: The DNB’s stress-testing framework is an important and evolving contribution.
- New analytical approaches based on forward-looking scenario analysis are needed to understand financial-stability impacts.
- Transition risk is a principal channel alongside physical and liability risks.
- Transition risk attributes highlighted: multifaceted, fundamentally uncertain, broad in scope across business models/sectors/geographies, large, potentially non-linear, irreversible, partly foreseeable, depends on short-term actions, and long/uncertain horizon.
- A key analytical next step is to capture second-round effects (e.g., asset price declines → fire sales → further price declines), which preliminary attempts suggest can be sizeable.

Fourth: Closing data gaps is critical.
- The FSB Task Force on Climate-Related Financial Disclosures supports voluntary private-sector disclosure; current disclosures remain uneven across asset classes and jurisdictions.
- Comprehensive climate stress testing requires improved provision and accessibility of high-quality data, including an internationally comparable taxonomy of green and brown assets and disclosure standards.
- Practical steps: central banks can disclose portfolio exposures to climate-related risks; some central banks already incorporate climate-related criteria to varying extents (examples cited: DNB, Swiss National Bank, Norges Bank).
- Open policy questions include whether climate disclosures should be mandated (example cited: French Energy Transition Law for public companies).

Fifth: The IMF is open to engagement and is focusing on related policy areas.
- The Fund’s overall focus has been on carbon pricing and related fiscal issues.
- Ensuring financial stability in the context of climate risks is an important IMF role; the IMF is liaising with central banks and other agencies and enhancing analysis of macrofinancial transmission of climate risks, including through stress tests.
- Urgency: “The potential impact of climate change compels us to think through these issues with urgency.”

The DNB framework applies forward-looking scenario analysis to assess risks from disruptive adjustments to a low-carbon economy.
Transition scenarios explored by DNB illustrate how policy shocks and technological shifts can materially affect asset valuations and financial-stability outcomes.
Important modeling objectives: quantify direct exposures, trace second-round amplification channels (fire-sale dynamics, balance-sheet feedbacks), and integrate sectoral and geographic heterogeneity.

Data needs:
- Industry classification of investment funds’ ultimate exposures.
- Comparable taxonomies for green and brown assets.
- High-quality, accessible disclosure across asset classes and jurisdictions.
Disclosure and policy choices:
- Voluntary versus mandated disclosure (example: French Energy Transition Law mandates disclosures for public companies).
- Consideration of climate criteria in central bank portfolio management and other policies.
- Central banks and supervisors can promote resilience through transparency of exposures and by informing market price signals.

“The task is large, the window of opportunity is short, and the stakes are existential.” — quoted from Mark Carney.
“The potential impact of climate change compels us to think through these issues with urgency.” — Tobias Adrian.

Remarks by Tobias Adrian, IMF, April 15, 2019.