A climate stress-test of the financial system

Abstract

The urgency of estimating the impact of climate risks on the financial system is increasingly recognized among scholars and practitioners. By adopting a network approach to financial dependencies, we look at how climate policy risk might propagate through the financial system. We develop a network-based climate stress-test methodology and apply it to large Euro Area banks in a ‘green’ and a ‘brown’ scenario. We find that direct and indirect exposures to climate-policy-relevant sectors represent a large portion of investors’ equity portfolios, especially for investment and pension funds. Additionally, the portion of banks’ loan portfolios exposed to these sectors is comparable to banks’ capital. Our results suggest that climate policy timing matters. An early and stable policy framework would allow for smooth asset value adjustments and lead to potential net winners and losers. In contrast, a late and abrupt policy framework could have adverse systemic consequences.

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Figure 1: Diagram illustrating the reclassification of sectors from NACE Rev2 codes into climate-policy-relevant sectors.
Figure 2: Equity holdings in EU and US listed companies in 2015 (data from Bureau Van Dijk Orbis).
Figure 3: First- and second-round losses in banks’ equity for the 20 most-severely affected EU listed banks, under the Fossil fuel + Utilities 100% shock.
Figure 4: Individual banks’ value at risk under green and brown investment strategies.

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Acknowledgements

The authors would like to thank J. E. Stiglitz and A. C. Janetos for fruitful comments on an early version of the paper, M. D’Errico for precious suggestions on macro-network data from the ECB Data Warehouse, and J. Glattfelder for help on equity holdings data extraction from Orbis. We also would like to thank A. Barkawi, P. Monnin and M. Tanaka for their comments during the Bank of England conference on Climate Change and Central Banking. S.B. acknowledges financial support from the Swiss National Fund Professorship grant no. PP00P1-144689. All the authors acknowledge the support of the European Projects Future and Emerging Technologies (FET) SIMPOL (grant no. 610704) and DOLFINS (grant no. 640772), and the European Project SEI Metrics (grant no. 649982).

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All authors contributed to the writing of the manuscript, as well as material and analysis tools. G.V. and S.B. also performed the data analysis.

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Correspondence to Stefano Battiston.

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The authors declare no competing financial interests.

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Battiston, S., Mandel, A., Monasterolo, I. et al. A climate stress-test of the financial system. Nature Clim Change 7, 283–288 (2017). https://doi.org/10.1038/nclimate3255

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