The Heat is on: a framework for measuring financial stress under disruptive energy transition scenarios

This paper presents a comprehensive framework for analyzing financial stress under scenarios with a disruptive transition to a low-carbon economy. This stress testing framework is designed to be readily applied by macroprudential supervisors or financial institutions. First, we construct stress scenarios using two dimensions: climate policy and energy technology. Then, we rely on various modeling approaches to derive macroeconomic and industry-specific implications. These approaches include a novel methodology for capturing industry-specific transition risks. Third, we disaggregate EUR 2.3 trillion in assets of more than 80 Dutch financial institutions by industry. Finally, our calculations show that financial losses can be sizeable, as portfolio values can decline by up to 11%. These outcomes suggest that climate-transition risks warrant close and timely attention from a financial stability perspective.
 
Keywords: climate transition risk, uncertainty, stress test, financial stability.
JEL classifications: G01, G20, Q43, Q54.

Working paper no. 625