Understanding impact of inclusion of climate risk in internal and external stress tests
By Doug Baird, Head of Climate Risk Analytics and Pension Risk, NatWest Markets
Why is it difficult to include climate risk in internal and external stress tests?
There are a number of challenges. For example, the forward looking nature of the risk drivers, with little precedent from recent history that models can be calibrated against.
There is also the challenge with the time horizon. Whilst there are some aspects of climate risk that absolutely will impact the normal planning horizon for a bank (eg sudden and disruptive policy action over the 2020s), there are other aspects which are expected to play out over decades rather than years
The cascade effect of climate risks, and how tipping points could dramatically increase the downsides (in particular for physical risk) do not lend themselves to traditional quantitative methods and so are difficult to properly capture in the analysis