A key role of central banks is to strive for financial stability. To assess climate destabilization risks, major central banks and supervisors plan to utilize a new set of climate scenarios developed by an international team of researchers.
The set of scenarios will inform the climate stress tests that key central banks like the Bank of England or the Banque de France are planning to apply to the financial institutions they regulate. The project was commissioned by the Network of Central Banks and Supervisors for Greening the Financial System (NGFS), a group of 66 central banks and supervisors around the globe who take an active interest in advancing the transition toward a sustainable world economy. The work was led by the Potsdam Institute for Climate Impact Research (PIK), while IIASA was one of the providers of transition scenarios and hosts the Scenario Explorer and database for the many users around the world. The transition scenarios explore future changes to the energy system and the global economy if climate targets are met or not, and whether the transition to a low-carbon future happens in an orderly or disorderly fashion.
“Climate-related risks are very real to the global economy,” explains Elmar Kriegler, lead coordinator of the project at PIK. “On the one hand, the physical impacts of climate and weather-related events can be very large – think of floods or droughts. On the other hand, there are transitional risks and opportunities. These arise for example from policy changes or technological development in the process of adjustment towards a low-carbon economy. Both risk types can heavily impact economies across the globe. But how precisely and under what conditions – that’s what our scenarios will help to illustrate and explore.”
According to the team, this type of information is critical for assessing financial risks, as central banks and supervisors have considerable leverage over the global economy’s future course. In their first comprehensive report from April 2019, the NGFS therefore issued six recommendations on how central banks and policymakers can ensure that the financial system is resilient to climate-related risks. One of those recommendations was to develop scenarios as a common starting point for analyzing climate risks to the economy and financial system. The overall goal is to provide tools for central banks and supervisors, policymakers, and financial actors, who aim to make finance greener and thus more sustainable – both for its own sake and for the sake of the planet.
“To enable financial specialists to work with the scenario data, we used the IIASA Scenario Explorer,” comments Bas van Ruijven, a senior researcher in the IIASA Energy Program. “Through this website, users can create their own graphics and workspaces of any aspects of these transition scenarios, such as macro-economic development, changes in energy consumption, or the exploitation of energy resources. Users can also download the full dataset, or just those parts of the data that they need to work with.”
The first round of scenarios was presented to the NGFS in June 2020, with a second round due to be released by the end of this year. Partners who participated in the first phase of the research included IIASA, the Potsdam Institute, Climate Analytics, the University of Maryland, and ETH Zurich.
“Science-based information is critical for sound decision making. In the course of the project, we experienced mutual learning between scenario modelers and central bankers. It was thrilling to see that climate change scenarios proved their worth for financial regulators as they have done before for climate policymakers,” Kriegler concludes.
Adapted from a press release prepared by the Potsdam Institute for Climate Impact Research (PIK).