Assessing financial risks from physical climate shocks: a framework for scenario generation

This paper aims to inform global and national discussions on scenarios for acute physical climate financial risk assessment. The primary goal is to inform ministries of finance, central banks, financial regulators, and financial institutions involved in climate financial risk assessments, both for micro- and macroprudential risk management. This includes climate stress testing applications and broader scenario analysis. It also has applications for financial institutions and investors using scenarios to incorporate climate risks into wider financial decision making, disclosures, and risk management.

The paper identifies five important areas to consider within a physical climate-related financial risk assessment and scenario design: (1) extreme weather events, (2) uncertainties in climate models, (3) compound scenarios, (4) indirect economic impacts of shocks, and (5) feedbacks between the real economy and the financial sector. The combination of these five areas within a climate-related financial risk assessment using simple scenarios is illustrated through the EIRIN macroeconomic model.