Society, desperate to reverse the effects of global warming, finds a spare pound coin behind the couch cushions. This being an abstract thought exercise, we are allowed to consider only three possible options for the bounty.
Category: Climate Risk
Whether climate risk is actually a threat to financial stability has been a subject of ongoing debate. But a recent regulator-driven stress test has offered some clarity on this hot-button subject.
Sometimes you perceive something as a major risk, but the reality exposed by the data just doesn’t live up to your expectations. This is, in fact, what many modelers (myself included) experienced during the pandemic: expectations were constantly challenged by data.
Consider a new pandemic scenario. In 2023, a pathogen will be discovered that, relative to COVID-19, is twice as deadly and five times as transmissible. It quickly becomes clear that vaccine development will be much more difficult than it was in 2020. Scientists estimate that 40% effectiveness is the best we can hope for, and that it will take at least three years to reach this level of development.
Honestly, this isn’t worthy of deep thought.
Compelling Climate Stress Testing
With COVID-19 vaccines now available, attention will soon revert to some of the other existential risks facing humankind. Top of the 2021 list for bank risk modelers, in the absence of new black swans, will undoubtedly be climate change. A number of key regulators have scheduled pilot stress testing projects in the coming year and the Bank of England has taken the bolder step of initiating a fully fledged regulatory stress test, known as the Climate Biennial Exploratory Scenario (CBES).
Modeling climate risk, and analyzing your risk of default, is extremely difficult – particularly if you are an electricity provider. All one has to do to realize the enormity of this challenge, and the potential havoc climate change can wreak on a business’ bottom line, is to consider recent events on either side of the Pacific.
Since the issue of climate change stress testing burst onto the radar screen, I’ve become a little obsessed by Hurricane Katrina. That event, in 2005, not only caused widespread human suffering and enormous insurance losses but also dramatically altered economic growth prospects for New Orleans, Louisiana and – more generally – Gulf Coast communities.
Climate Change Stress Testing
For risk modelers at lending institutions, climate change represents an enormous challenge. Until now, stress testing has focused on acute short- and medium-term recession risk and has avoided questions of long-term strategic risk management. Climate change is a slow-moving train wreck that has been happening, very gradually, across the span of most bank databases.