Climate-Related Stress Testing: Transition Risk in Colombia

IMF Working Papers, November 5, 2021

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Builds a framework to quantify the financial stability implications of climate-related transition risk in Colombia.
Explores risks imposed on the banking system based on scenarios of an increase in the domestic carbon tax.
Uses bank- and firm-level data.
Focuses on the deterioration of firms’ balance sheets and the exposure of banks to different sectors to assess transmission from nonfinancial firms to the banking system.

Sectors are affected unevenly by a higher carbon tax.
The following sectors appear to be the most important in the transmission of the risk to the banking system:
- Agriculture
- Manufacturing
- Electricity
- Wholesale and retail trade
- Transportation
A large increase in the carbon tax can generate significant but likely manageable financial stability risks.
A gradual increase in the carbon tax to meet a higher target over several years could be preferable in terms of financial risks.
A gradual increase would also allow for a smoother adjustment to higher carbon tax for stakeholders.

Consider gradual implementation of higher carbon tax targets spread over several years to reduce near-term financial stability risks.
Monitor sectoral exposures in banks, giving attention to agriculture, manufacturing, electricity, wholesale and retail trade, and transportation.
Use bank- and firm-level data to assess potential deterioration in firms’ balance sheets and the consequent transmission to the banking system.