What Is Climate Stress Testing?

Climate scenario analysis and stress testing explores the financial impacts and exposures on firms’ balance sheets and the financial system under a range of different potential climate pathways.

Banking supervisors and other regulators are increasingly asking financial services businesses to incorporate climate change scenarios into their risk and stress-testing processes. This enables them to ensure that banks have sufficient capital to maintain operations during adverse climate scenarios or policy shocks. For example:

• The Bank of England’s Climate Biennial Exploratory Scenario
• The ECB’s economy-wide climate stress test
• The Federal Reserve

Stress testing involves working with climate scenarios, or transition pathways, such as the Network for Greening the Financial System (NGFS) Climate Scenarios or the IPCC’s Representative Concentration Pathways (RCPs), which are generated from Integrated Assessment Models (IAMs) and can be accessed through MATLAB^® with the Climate-IAM-Explorer.

Combining climate data with the tools in the Statistics and Machine Learning Toolbox™, Financial Toolbox™, and Risk Management Toolbox™ enables users to do the following:

• Map scenario transitions to financial shocks and the impact on loan portfolios based on the CLIMAFIN^® methodology 
  
• Model the impact of climate risks on mortgages
• Mitigate climate risks using credit and weather derivatives
• Integrate physical climate data with the Climate Data Toolbox for MATLAB
• Perform Monte Carlo simulations
• Measure the temperature impact of an equity portfolio using the Science Based Targets (SBTi) framework
• Measure transition risk for loan portfolios with respect to climate scenarios
• What is Physical Risk?