Climate stress tests differ from regular stress tests
Published: 25 January 2023
Climate stress tests can be designed as a kind of stress test of banks’ capital. However, several aspects distinguish climate stress tests from ordinary capital stress tests. First, the scenarios used are different. In a climate stress test, the scenario is based on the materialisation of physical risks, transition risks or a combination of these. Climate change and measures adopted to counter it can be affected by each other. For example, faster climate change may lead to stronger measures. One possible scenario could be the introduction of a high carbon tax. Another difference is that climate change evolves and climate policy measures have effects over long periods of time. This means that the time horizon in climate stress tests may be longer than in normal stress tests.
Household and corporate exposures to climate risks are complex and the data used in the stress test must be able to capture this. The data requirements are therefore high. A further difference compared with standard stress tests is that historical data are less useful. This applies mainly to risks associated with the climate transition, as we have never experienced one before and thus cannot learn from earlier transitions. Climate stress tests are influenced partly by the expected effects of climate change and partly by expected climate policy measures. Ideally, the same stress test should be repeated regularly to get an idea of how risks evolve over time. This makes it even more difficult to design climate stress tests.